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PERFORMANCE OPERATIONS

According to the following syllabus CMA (Operational Level), ICMAB Public, Private & National University BBA & BBS Honors in Accounting, Finance

Md. Sajjad Hossain CMA (4th Part), ITP, MBA, BBA, LLB Income Tax Lawyer Member, Dhaka Taxes Bar Association Income Tax and Company Law Adviser

NOBBODOY PUBLICATION DHAKA, BANGLADESH


No part of this publication may be reproduced, stored, transmitted in any form or by any means of electronic, photocopying, recording or otherwise, without the prior written permission of the Author. All rights reserved.

Edition: July 2018

Presented by: Nobbodoy Publication Dhaka, Bangladesh.

Designed by: Nobbodoy Nilkhet, Dhaka, Bangladesh.

Price: BDT 280.00 only

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SERIAL NUMBER

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This serial number is useful in following cases: * To get our helpline facilities * To collect exercises solution

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PREFACE

With the growing demand of education, Accounting has gained a huge popularity. An Accounting degree makes the candidates suitable for lots of opportunities. As more and more multi-nationals are coming into the world, demand for Accounting degree has further increased. The employment peripheries for Accountants are various and can range from holding key positions in a company. The main objective of this book is to meet the basic requirements of the Accounting courses. It is helpful for professional students and the persons who are intended to get admission into a professional institute. This book is written by following the syllabus of The Institute of Cost and Management Accountants of Bangladesh, Public and Private University, and National University of Bangladesh for the relative subject. I am grateful and deserve our thanks to the publishers, printers and designers of this book. Any criticism, favorable or unfavorable, and any constructive suggestion in regards of this book will be gratefully received.

Date: July 2018

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Md. Sajjad Hossain


Dedicated to my parents

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BRIEF TABLE OF CONTENTS

Chapter

5

Topic

Page

1

Cost accounting systems

11

2

Variance analysis

42

3

Forecasting and budgeting techniques

67

4

Project appraisal

128

5

Investment appraisal

170

6

Dealing with uncertainty in analysis

186

7

Managing short term finance

235

8

Economic order quantity

251


র্঴.এম.এ প্রস্তুর্ত ক্লার঴ ভর্তি চ঱রে!

আমারের ববর্লষ্ট্যেঃ

√ আমাদের ঴ক঱ শলক্ষক ও শলক্ষার্থী প্রদেলনা঱ প্রশিষ্ঠাদনর; √ শ঴.এম.এ ব্যাদের ঴ক঱ ছাত্র–ছাত্রী আই.শ঴.এম.এ.শব্ প্রশিষ্ঠাদনর; √ শব্঳য় ও অধ্যায় শিশিক ল঱কোর শলট প্রোন করা ঵য়; √ শ঴.এম.এ শ঴দ঱ব্াদ঴র পালাপাশল শব্গি ব্ছদরর প্রশ্ন ঴মাধ্ান করা ঵য়; √ একাউশটিং শব্঳য় ঴মূদ঵ আই.এে.আর.এ঴ অনু঴রন করা ঵য়; √ গাশিশিক ঴ম঴যা ঴মাধ্াদনর ঴঵জ লকৌল঱ ললখাদনা ঵য়; √ শ঴.এম.এ পরীক্ষার অনুরূপ ক্লাল লটস্ট ও মদে঱ লটস্ট লনওয়া ঵য়।

যযাগারযারগেঃ নব্যেয় ঢাকা, ব্ািং঱াদেল। লমাব্াই঱ঃ ০১৭১১১৩৭০৩৯

শুক্রবাররর বযাচ ররেরে! ফ্রী ক্লা঴ করর ভর্তির র্঴দ্ধান্ত র্িি!

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DETAILED TABLE OF CONTENTS

Chapter 1: Cost accounting systems 1.1. Definition of marginal accounting systems 1.2. Advantages of marginal accounting system 1.3. Disadvantages of marginal accounting system 1.4. Concept of throughput accounting system 1.5. Definition of absorption accounting systems 1.6. Advantages of absorption accounting system 1.7. Disadvantages of absorption accounting system 1.8. Differences between marginal and absorption accounting systems 1.9. Meaning of just-in-time 1.10. Benefits of just-in-time 1.11. Limitations of just-in-time 1.12. Meaning of total quality management 1.13. Basic principles of total quality management 1.14. Theory of constraints 1.15. Five focusing steps of theory of constraints 1.16. Concepts of MRP and ERP systems 1.17. Differences between MRP and ERP systems 1.18. Short notes

Page 11 11 11 11 11 11 12 12 12 12 12 13 13 13 14 14 14 15 15

Problems and solutions Exercises

17 32

Chapter 2: Variance analysis 2.1. Definition of variance analysis 2.2. Types of variance analysis 2.3. Meaning of standard costing 2.4. Reasons for using standard costing 2.5. Standard cost and standard cost card 2.6. Types of cost standards 2.7. Advantages of standard costing 2.8. Disadvantages of standard costing

42 42 42 44 44 44 44 45 45

Problems and solutions

47

Chapter 3: Forecasting and budgeting techniques 3.1. Definition of forecasting 3.2. Role of forecasting 3.3. Different methods of forecasting 3.4. Definition of budget 3.5. Purposes of budget 3.6. Advantages of budget 3.7. Mechanics of budget construction 3.8. Components of budget 3.9. Functional and master budget

67 67 67 68 68 68 69 69 70 70

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3.10. Incremental and zero based budgeting 3.11. Impact of zero based budgeting on stockholders 3.12. Budgetary control report 3.13. Characteristics of budgetary control report 3.14. Objectives of budgetary control report 3.15. Fixed versus flexible budget 3.16. Budgeted income statement 3.17. Uses of budget statement 3.18. Definition of cash budget 3.19. Methods of preparing cash budget

71 71 71 71 71 72 72 72 73 73

Problems and solutions Exercises

75 113

Chapter 4: Project appraisal 4.1. Definition of activity based costing 4.2. Advantages of activity based costing 4.3. Disadvantages of activity based costing 4.4. Definition of traditional costing 4.5. Weakness of traditional costing for allocating overhead 4.6. Differences between activity based costing and traditional costing 4.7. Implications of switching to activity based costing system 4.8. Short notes

128 128 128 128 129 129 129 129 130

Problems and solutions Exercises

131 153

Chapter 5: Investment appraisal 5.1. Definition of investment appraisal 5.2. Reasons for investment on capital 5.3. Techniques of investment appraisal 5.4. Advantages and disadvantages of different investment appraisal techniques 5.5. Method of discounting 5.6. Need for method of discounting 5.7. Differences between discounting and compounding 5.8. Concept of sensitivity analysis 5.9. Uses of sensitivity analysis 5.10. Measurement of sensitivity analysis

170 170 170 170 171 172 172 172 172 173 173

Problems and solutions

175

Chapter 6: Dealing with uncertainty in analysis 6.1. Definition of risk 6.2. Types of risk 6.3. Nature of risk and uncertainty 6.4. Sensitivity analysis in decision making 6.5. Concept of decision tree 6.6. Uses of decision tree 6.7. Drawing a decision tree 6.8. Advantages of decision tree

186 186 186 186 186 186 187 187 187 8


6.9. Limiting factor analysis 6.10. Make or buy decision 6.11. Factors influencing make or buy decision 6.12. Sales mix analysis 6.13. Importance of sales mix analysis

188 188 188 189 189

Problems and solutions Exercises

190 211

Chapter 7: Managing short term finance 7.1. Definition of working capital ratio 7.2. Definition of working capital cycle 7.3. Types of working capital ratios 7.4. Definition of short-term finance 7.5. Features of short-term finance 7.6. Concept of export finance

235 235 235 235 237 237 237

Problems and solutions

240

Chapter 8: Economic order quantity 8.1. Meaning of economic order quantity 8.2. Principles of economic order quantity model 8.3. Criticisms of economic order quantity model 8.4. Definition of centralised and decentralised purchasing 8.5. Centralised versus decentralised purchasing 8.6. Relationship between purchasing and stock control 8.7. Definition of inventory management system 8.8. Objectives of inventory management system 8.9. Definition of inventory control system 8.10. Classification of inventory control system 8.11. Short notes

251 251 251 251 251 251 252 252 252 252 252 253

Problems and solutions Exercises

255 266

Model exam question Model exam question solution

275 279

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যমা঴াজ এন্ড এর঴ার্঴রেট঴

য঴বা঴মূ঵েঃ

√ শ঵঴াব্ প্রস্তুিকরন √ আশর্থিক শব্ব্রিী প্রস্তুিকরন √ ইন্টারনা঱ অশেট √ টিআইএন লরশজদেলন √ শরটানি প্রস্তুিকরন √ শরটানি অনুযায়ী কর পশরদলাধ্ করা √ শরটানি োশখ঱ করা √ কর প্রোদনর প্রাশি-স্বীকারপত্র ঴িংগ্র঵ করা √ কর পশরদলাদধ্র ঴াটিিশেদকট ঴িংগ্র঵ করা √ শরটাদনির প্রিযশয়ি কশপ ঴িংগ্র঵ করা

র্বরল঳ত্বেঃ আয়কর আইনজীব্ী ঴ে঴য – ঢাকা টযাদে঴ ব্ার এদ঴াশ঴দয়লন

যযাগারযারগেঃ লমা঴াজ এন্ড এদ঴াশ঴দয়ট঴ ঢাকা, ব্ািং঱াদেল। লমাব্াই঱ঃ ০১৫১১১৩৭০৩৯

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CHAPTER - 1 COST ACCOUNTING SYSTEMS

1.1. DEFINITION OF MARGINAL ACCOUNTING SYSTEM Marginal (or variable) accounting system is the accounting system in which variable costs are charged to cost units and fixed costs of the period are written off in full against the aggregate contribution. It includes only the variable costs of the product into the calculation of cost of goods sold to determine the contribution margin, as opposed to a gross margin produced under absorption costing. This usually includes direct materials, direct labor, and the variable portion of manufacturing overhead. Fixed manufacturing cost is not treated as a product cost under marginal costing. 1.2. ADVANTAGES OF MARGINAL ACCOUNTING SYSTEM (i) It is easy to understand and use. It is applicable to standard costing and budgetary control. (ii) It assists the planners to forecast sales and set production strategy efficiently. (iii) It concentrates management on controlling the controllable costs i.e , direct costs and avoids the tension of allocating the fixed cost without taking any basis. (iv) It assists management for taking rational decision regarding profit planning and cost control. 1.3. DISADVANTAGES OF MARGINAL ACCOUNTING SYSTEM (i) Difficulty in segregating overhead cost into fixed and variable cost. (ii) It is not justifiable to exclude fixed manufacturing overhead from inventories. (iii) Wide fluctuation in profits due to seasonal demand. (iv) Variable costing is not useful for long term planning and decision making. (v) Variable costing is not acceptable for external reporting purpose. 1.4. CONCEPT OF THROUGHPUT ACCOUNTING SYSTEM Throughput accounting is a principle-based and simplified management accounting approach that provides managers with decision support information for enterprise profitability improvement. Throughput accounting is relatively new in management accounting. It is an approach that identifies factors that limit an organization from reaching its goal, and then focuses on simple measures that drive behavior in key areas towards reaching organizational goals. 1.5. DEFINITION OF ABSORPTION ACCOUNTING SYSTEM Absorption accounting system means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method.

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1.6. ADVANTAGES OF ABSORPTION ACCOUNTING SYSTEM (i) The pricing based on absorption costing ensures that all costs are covered. (ii) It shows correct profit calculation than variable costing in a situation where production is done to have sales in future (e.g. seasonal production and seasonal sales). (iii) It conforms with accrual and matching accounting concepts which requires matching costs with revenue for a particular accounting period. (iv) It has been recognized for the purpose of preparing external reports and for stock valuation purposes. (v) It avoids the separating of costs into fixed and variable elements. 1.7. DISADVANTAGES OF ABSORPTION ACCOUNTING SYSTEM (i) It is not useful for decision making. Various types of managerial problems relating to decision making can be solved only with the help of variable costing system. (ii) It considers fixed manufacturing overhead as product cost which increase the cost of output. As a result, it does not help in accepting specially offered price for the product. (iii) It is not helpful in control of cost and planning and control functions. It is not useful in fixing the responsibility for incurrence of costs. 1.8. DIFFERENCES BETWEEN ACCOUNTING SYSTEM

MARGINAL

AND

ABSORPTION

(i) Only the variable cost is applied to inventory under marginal accounting system, while fixed overhead costs are also applied under absorption accounting system. (ii) The profitability of each individual sale will appear to be higher under marginal accounting system, while profitability will appear to be lower under absorption accounting system. (iii) The measurement of profits under marginal accounting system uses the contribution margin (which excludes applied overhead), while the gross margin (which includes applied overhead) is used under absorption accounting system. (iv) Overhead costs are charged to expense in the period under marginal accounting system, whereas they are applied to products under the absorption accounting system. (v) Absorption accounting system is required by the applicable accounting frameworks for financial reporting purposes, so that factory overhead will be included in the inventory asset. Marginal accounting system is not allowed for financial reporting purposes, so its use is restricted to internal management reports. 1.9. MEANING OF JUST-IN-TIME Just-in-time (JIT) is an inventory strategy companies employ to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing inventory costs. This method requires producers to forecast demand accurately. 1.10. BENEFITS OF JUST-IN-TIME (i) There should be minimal amounts of inventory obsolescence, since the high rate of inventory turnover keeps any items from remaining in stock and becoming obsolete. 12


(ii) Since production runs are very short, it is easier to halt production of one product type and switch to a different product to meet changes in customer demand. (iii) The very low inventory levels mean that inventory holding costs (such as warehouse space) are minimized. (iv) The company is investing far less cash in its inventory, since less inventory is needed. (v) Less inventory can be damaged within the company, since it is not held long enough for storage-related accidents to arise. Also, having less inventory gives materials handlers more room to maneuver, so they are less likely to run into any inventory and cause damage. (vi) Production mistakes can be spotted more quickly and corrected, which results in fewer products being produced that contain defects. 1.11. LIMITATIONS OF JUST-IN-TIME (i) A supplier that does not deliver goods to the company exactly on time and in the correct amounts could seriously impact the production process. (ii) A natural disaster could interfere with the flow of goods to the company from suppliers, which could halt production almost at once. (iii) An investment should be made in information technology to link the computer systems of the company and its suppliers, so that they can coordinate the delivery of parts and materials. (iv) A company may not be able to immediately meet the requirements of a massive and unexpected order, since it has few or no stocks of finished goods. 1.12. MEANING OF TOTAL QUALITY MANAGEMENT A core definition of total quality management (TQM) describes a management approach to long–term success through customer satisfaction. In a TQM effort, all members of an organization participate in improving processes, products, services, and the culture in which they work. It consists of organization-wide efforts to install and make permanent a climate in which an organization continuously improves its ability to deliver high-quality products and services to customers. 1.13. BASIC PRINCIPLES OF TOTAL QUALITY MANAGEMENT (i) Customer Centric Approach – Consumers are the ultimate judge to determine whether products or services are of superior quality or not. Companies must remember to implement TQM across all fronts keeping in mind the customers. (ii) Employee Involvement – Ensuring total employee involvement in achieving goals and business objectives will lead to employee empowerment and active participation from the employees in decision making and addressing quality related problems. (iii) Continual Improvement – A major component of TQM is continual improvement. Continual improvement will lead to improved and higher quality processes. (iv) Strategic Approach to Improvement – Businesses must adopt a strategic approach towards quality improvement to achieve their goals, vision, and mission.

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(v) Integrated System – Businesses comprise of various departments with different functionality purposes. These functionalities are interconnected with various horizontal processes TQM focuses on. Everyone in the company should have a thorough understanding of the quality policies, standards, objectives, and important processes. 1.14. THEORY OF CONSTRAINTS The theory of constraints is a methodology for identifying the most important limiting factor (i.e. constraint) that stands in the way of achieving a goal and then systematically improving that constraint until it is no longer the limiting factor. In manufacturing, the constraint is often referred to as a bottleneck. The essential concept of theory of constraints is that every organization must have at least one constraint. A constraint is any factor that limits the organization from getting more of whatever it strives for, which is usually profit. The Goal focuses on constraints as bottleneck processes in a job-shop manufacturing organization. However, many nonmanufacturing constraints exist, such as market demand, or a sales department‟s ability to translate market demand into orders. 1.15. FIVE FOCUSING STEPS OF THEORY OF CONSTRAINTS The continuous improvement method to increase throughput in any system of value creation, known as the five focusing steps: Step 1: Identify the constraint: This tells us where to focus our improvement efforts, since we know that only an improvement at the constraint makes a difference. Step 2: Optimize the constraint: Before adding capacity, we need to use the capacity we already have. “Optimize” in this sense means “doing everything possible to use the constraint to its fullest capacity.” Step 3: Subordinate the non-constraints: The job of all non-constraints is to subordinate their decisions to the constraint‟s needs. They should optimize for constraint (and thus system) performance, not their own individual performance. Step 4: Elevate the constraint: Only once we‟ve completed the previous steps does it make sense to add more constraint capacity, and thereby increase system performance. Because adding capacity is tremendously expensive in terms of time and money, we do it as a last resort, not a first resort. Step 5: Return to step 1: The inevitable result of the first four steps, and the reason this is a “continuous” improvement method, is that the constraint moves somewhere else. This step insists that you start back at the beginning, and don‟t let inertia become the constraint. 1.16. CONCEPTS OF MRP AND ERP SYSTEMS Manufacturing resource planning (MRP) is defined as a method for the effective planning of all resources of a manufacturing company. Ideally, it addresses operational planning in units, financial planning, and has a simulation capability to answer "what-if" questions and extension of closed-loop MRP. 14


Enterprise resource planning (ERP) is business process management software that allows an organization to use a system of integrated applications to manage the business and automate many back office functions related to technology, services and human resources. 1.17. DIFFERENCES BETWEEN MRP AND ERP SYSTEMS MRP (Manufacture Resource Planning) is more focused on planning for use of materials required to produce a business product, whereas ERP (Enterprise Resource Planning) takes in the whole ecosphere of a business not just the manufacturing components, areas such as finance, HR, workforce, and property are all parts of an ERP system. 1.18. SHORT NOTES Benchmarking: Benchmarking is a process of measuring the performance of a company‟s products, services, or processes against those of another business considered to be the best in the industry. The point of benchmarking is to identify internal opportunities for improvement. In essence, benchmarking helps employees understand how one small piece of a company‟s processes or products can be the key to major success, just as one employee‟s contributions can lead to a big win. Back-flush accounting: Back-flush accounting is a certain type of "post production issuing", it is a product costing approach, used in a Just-In-Time (JIT) operating environment, in which costing is delayed until goods are finished. Standard costs are then flushed backwards through the system to assign costs to products. Cost reduction: Cost reduction is the process used by companies to reduce their costs and increase their profits. Depending on a company's services or product, the strategies can vary. Every decision in the product development process affects cost. Employee participation: Employee participation is the process whereby employees are involved in decision making processes, rather than simply acting on orders. Employee participation is part of a process of empowerment in the workplace.

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MARGINAL COSTING PROFIT STATEMENT FORMAT Currency Sales Less. Variable cost of goods sold: Opening inventory Add. Variable manufacturing costs Less. Closing inventory

X X X (X)

Less. Variable selling, distribution and administrative costs Contribution margin Less. Fixed costs: Production costs Selling, distribution and administration costs Net profit/ (loss)

X X

Currency X

(X) X (X) X

(X) X/ (X)

ABSORPTION COSTING PROFIT STATEMENT FORMAT Currency Sales Less. Cost of goods sold: Opening inventory Add. Manufacturing costs Less. Closing inventory Over/ (Under) applied overhead Gross profit Less. Selling, distribution and administration costs: Variable Fixed Net profit/ (loss)

X X X (X)

X X

Currency X

(X) X +/X

(X) X/ (X)

RECONCILIATION OF PROFITS FORMAT Net profit under marginal costing Add. Increase/ (Decrease) in inventory X Fixed manufacturing cost per unit Net profit under absorption costing

Currency X X/ (X) X

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PROBLEMS AND SOLUTIONS P-1. Nobbodoy Limited produces frozen youghurt, a low-fat dessert. The product is sold in five litre containers and had the following price and variable costs per unit in the current year. Selling price Tk.50 Direct material 10 Direct labour 4 Variable overhead 6 Budgeted fixed overhead for the current year was Tk.800,000, which was equal to actual fixed overhead. Actual production was 200,000 five-litre containers, which was equal to the budgeted level of production, but only 150,000 containers were sold. Nobbodoy Limited incurred the following selling and administrative expenses: Fixed Tk.250,000 Variable Tk.3 per container sold. Required: (a) Calculate the cost per unit under absorption and marginal costing. (b) Prepare income statements for the current year using: (i) Absorption costing; (ii) Marginal costing. (c) Reconcile the profits reported under the two methods. Solution: (a) Calculation of cost per unit: Absorption costing Tk.10 4 6

Direct material Direct labour Variable overhead Fixed overhead (

Tk.800,000 ) 200,000 units

Marginal costing Tk.10 4 6

4

-

24

20

(b) (i) Nobbodoy Limited Income statement (Under absorption costing) For the current year Tk. Sales (150,000 X Tk.50) Less: Cost of goods sold: Beginning inventory Add. Manufacturing cost (200,000 X Tk.24) Less. Ending inventory (200,000-150,000) X Tk.24

Tk. 75,00,000

0 48,00,000 48,00,000 (12,00,000) (36,00,000)

17


Gross margin Less. Selling & administrative expenses (150,000XTk.3)+Tk.250,000 Net profit

39,00,000 (7,00,000) Tk.32,00,000

(ii) Nobbodoy Limited Income statement (Under marginal costing) For the current year Tk. Sales (150,000 X Tk.50) Less: Variable cost of goods sold: Beginning inventory Add. Variable manufacturing cost (200,000 X Tk.20) Less. Ending inventory (200,000-150,000) X Tk.20

Tk. 75,00,000

0 40,00,000 40,00,000 (10,00,000)

Less. Variable selling & administrative expenses (150,000XTk.3) Contribution margin Less. Fixed manufacturing overhead (200,000XTk.4) Fixed selling & administrative expenses Net profit (c) Reconciliation of profits: Net profit under marginal costing Add. Fixed manufacturing overhead cost deferred in inventory under absorption costing (200,000-150,000) units X Tk.4 Net profit under absorption costing

(30,00,000) 45,00,000 (4,50,000) 40,50,000 (800,000) (2,50,000) 30,00,000

Tk.30,00,000 200,000 32,00,000

P-2. Delta Company produces a single product with the following budget: Single price Direct Materials Direct wages Variable overhead Fixed overhead

Tk.20 per unit 5 ,, ,, 3 ,, ,, 2 ,, ,, Tk.20,000 per month

The fixed overhead absorption rate is based on a volume of 10,000 units per month. During the month of June 2018 production was 5,500 units and sales were 5,000 units. The company has no beginning inventory. Required: (a) Show the operating statement for the month under: - Absorption costing and - Marginal costing (b) Reconcile the difference in reported profit. Solution:

18


Calculation of cost per unit: Absorption costing Tk. 5 3 2

Direct material Direct wages Variable overhead Fixed overhead (

Tk.20,000 ) 10,000 units

Marginal costing Tk. 5 3 2

2

-

Tk.12

Tk.10

(a) Delta Company Operating statement (Under absorption costing) For the month of June 2018 Tk. Sales (5,000 X Tk.20) Less: Cost of goods sold: Beginning inventory Add. Manufacturing cost (5,500 X Tk.12) Less. Ending inventory (5,500-5,000) X Tk.12

Tk. 100,000

0 66,000 66,000 (6,000) (60,000) 40,000 (9,000) Tk.31,000

Gross margin Less. Under applied overhead (w-1) Operating profit Delta Company Operating statement (Under marginal costing) For the month of June 2018 Tk. Sales (5,000 X Tk.20) Less: Variable cost of goods sold: Beginning inventory Add. Variable manufacturing cost (5,500 X Tk.10) Less. Ending inventory (5,500-5,000) X Tk.10

Tk. 100,000

0 55,000 55,000 (5,000)

Contribution margin Less. Fixed overhead Operating profit

(50,000) 50,000 (20,000) Tk.30,000

(b) Difference in profit: Operating profit under absorption costing Operating profit under marginal costing Difference

Tk.31,000 Tk.30,000 Tk.1,000

19


Reconciliation: (Ending inventory – Beginning inventory) X Fixed manufacturing cost per unit = (500 - 0) units X Tk.2 = 500 units X Tk.2 = Tk.1,000 Working: 1. Calculation of over or under applied overhead: Budgeted fixed overhead Applied fixed overhead (5,500 units X Tk.2) Under applied overhead

Tk.20,000 Tk.(11,000) Tk.9,000

P-3. Keya & Co. produces and sells a single product, a wooden hand loom for weaving small item such as scarves. Selected cost and operating data relating to the product for two years are given below: Year 1 Year 2 Units in beginning inventory 0 2,000 Units produced during the year 10,000 6,000 Units sold during the year 8,000 8,000 Units in ending inventory 2,000 0 Taka Selling price per unit 50 Direct material cost per unit 11 Direct labor cost per unit 6 Variable manufacturing overhead cost per unit 3 Fixed manufacturing overhead cost per year 120,000 Variable selling and administrative cost per unit sold 5 Fixed selling and administrative costs per year 70,000 Required: (a) Prepare an income statement for each year assuming that the company uses absorption costing. (b) Prepare an income statement for each year assuming that the company uses variable costing. (c) Reconcile the variable costing and absorption costing net operating income. Solution: Computation of unit product cost:

Direct material Direct labor Variable manufacturing overhead Fixed manufacturing overhead Tk.120,000÷10,000 units Tk.120,000÷6,000 units

Absorption costing Year-1 Year-2 Tk. Tk. 11 11 6 6 3 3 12 Tk.32

Variable costing Year-1 Year-2 Tk. Tk. 11 11 6 6 3 3

20 Tk.40

Tk.20

Tk.20

20


(a) Keya & Co. Income statement under absorption costing Year-1 Tk. Tk. 400,000

Sales Less: Cost of goods sold: Beginning inventory 0 Add. Manufacturing cost available for sale 320,000 320,000 Less. Ending inventory 64,000 Cost of goods sold 256,000 Gross margin 144,000 Less. Selling & administrative expenses (110,000) (8,000 X Tk.5) + Tk.70,000 Net operating income (loss) Tk.34,000

Year-2 Tk.

Tk. 400,000

64,000 240,000 304,000 0 304,000 96,000 (110,000) Tk.(14,000)

(b) Keya & Co. Income statement under variable costing Year-1 Tk. Tk. 400,000

Year-2

Tk. Tk. Sales 400,000 Less: Variable expenses: Variable cost of goods sold: Beginning inventory 0 40,000 Add. Variable manufacturing cost 200,000 120,000 available for sale 200,000 160,000 Less. Ending inventory 40,000 ____0 Variable cost of goods sold 160,000 160,000 Variable selling & administrative expenses 40,000 40,000 Total variable expenses 200,000 200,000 Contribution margin 200,000 200,000 Less. Fixed expenses: Fixed manufacturing overhead 120,000 120,000 Fixed Selling & administrative expenses 70,000 70,000 Total fixed expenses 190,000 190,000 Net operating income Tk.10,000 Tk.10,000 (c) Reconciliation of net operating income: Year-1 Tk. 10,000

Net operating income under variable costing Add. Fixed manufacturing overhead cost deferred in inventory under absorption costing (2,000-0) units X Tk.12 24,000 Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (0-2,000) units X Tk.12 Net operating income (loss) under absorption costing Tk.34,000 21

Year-2 Tk. 10,000

(24,000) Tk.(14,000)


P-4. Aleya Ltd. has the following data for 2016 and 2017: Basic production data at standard cost: Direct materials Direct labor Variable overhead Fixed overhead (Tk.1,50,000 / 1,50,000 units of normal volume) Total standard factory cost Other expenses: Fixed selling and administration Sales commission Output and sales in units: 2016 Opening stock --Production 1,70,000 Sales 1,40,000 Closing stock 30,000

Tk.1.30 1.50 0.20 1.00 4.00 5.00 Tk.65,000 4% of sales value 2017 30,000 1,40,000 1,60,000 10,000

Required: (a) A profit statement for each of the two years 2016 and 2017 under (i) Absorption Costing; (ii) Marginal Costing. (b) A reconciliation of the difference in net profit reported under the two systems. Solution: (a) (i) Aleya Limited Profit Statement under Absorption Costing Particulars Sales (140,000 X 5), (160,000 X 5) Direct material (170,000 X 1.30), (140,000 X 1.30) Direct labor (170,000 X 1.50), (140,000 X 1.50) Variable overhead (170,000 X 0.20), (140,000 X 0.20) Fixed overhead (170,000 X 1), (140,000 X 1) Cost of goods manufactured Add. Opening inventory (30,000 X 4) Cost of goods available for sale Closing inventory Cost of goods sold Over and under recovered of overhead Adjusted cost of goods sold Gross margin Less. Fixed selling & administrative expenses Less. Sales commission @ 4% Net profit

2016 Tk. 700,000 221,000 255,000 34,000 170,000 680,000 _____680,000 120,000 560,000 (20,000) 540,000 160,000 65,000 95,000 28,000 67,000

2017 Tk. 800,000 182,000 210,000 28,000 140,000 560,000 120,000 680,000 40,000 640,000 (10,000) 650,000 150,000 65,000 85,000 32,000 53,000 22


(ii) Aleya Limited Profit Statement under Marginal Costing Particulars

2016 Tk. 700,000 221,000 255,000 34,000 510,000 _____510,000 90,000 420,000 28,000 448,000 252,000 215,000 37,000

2017 Tk. 800,000 182,000 210,000 28,000 420,000 90,000 510,000 30,000 480,000 32,000 512,000 288,000 215,000 73,000

2016 67,000 37,000 30,000

2017 53,000 73,000 (20,000)

Absorption costing closing inventory (Units) Marginal costing closing inventory (Units) Difference in closing inventory (Units) (A)

120,000 90,000 30,000

40,000 30,000 10,000

Absorption costing opening inventory (Units) Marginal costing opening inventory (Units) Difference in opening inventory (Units) (B) Net difference in inventory (Units) (A - B) Fixed manufacturing cost per unit (Tk.) Difference explained

________30,000 1 30,000

120,000 90,000 30,000 (20,000) 1 (20,000)

2016 Tk. 65,000 150,000 215,000

2017 Tk. 65,000 150,000 215,000

Sales (140,000 X 5), (160,000 X 5) Direct material (170,000 X 1.30), (140,000 X 1.30) Direct labor (170,000 X 1.50), (140,000 X 1.50) Variable overhead (170,000 X 0.20), (140,000 X 0.20) Variable cost of goods manufactured Add. Opening inventory Cost of goods available for sale Closing inventory Variable cost of goods sold Sales commission Total variable costs Contribution margin Less. Fixed costs (W-1) Net profit (b) Aleya Limited Statement showing reconciliation of profit Particulars Profit as per absorption costing (Tk.) Profit as per marginal costing (Tk.) Difference to be explained (Tk.)

Working: 1. Fixed costs:

Fixed selling and administrative expenses Fixed overhead

23


P-5. The Mosaj & Associates manufactures trendy, high-quality moderately priced watches. As Mosaj & Associates senior financial analysts, you are asked to recommend a method of inventory costing. The CFO will use your recommendation to construct Mosaj & Associates 2017 income statement. The following data are for the year ended December 31, 2017: Beginning inventory, January 1, 2017 Ending inventory, December 31, 2017 Sales during 2017 Selling price (to distributor) Variable manufacturing cost per unit (including direct material) Variable operating cost per unit sold Fixed manufacturing overhead Denominator-level machine-hours Standard production rate Fixed operating costs

85,000 units 34,500 units 345,400 units Tk.22.00 per unit Tk.5.10 per unit Tk.1.10 per unit sold Tk.1,440,000 6,000 hours 50 units per machine-hour Tk.1,080,000

Assume standard costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume no price, spending, or efficiency variances. (a) Prepare income statements under marginal costing for the year ended December 31, 2017. (b) Prepare income statements under absorption costing for the year ended December 31, 2017. (c) What is Mosaj & Associates operating income under each costing method (in percentage terms)? (d) Explain the difference in operating income between the two methods. (e) Which costing method would you recommended to the CFO? Why? Solution: (a) Mosaj & Associates Income statement for the year ended December 31, 2017 Under marginal costing Particulars Taka Revenues (Tk.22 X 345,400) Variable costs: Beginning inventory (Tk.5.10 X 85,000) 4,33,500 Add. Variable manufacturing costs (Tk.5.10 X 294,900*) 15,03,990 Variable cost of goods available for sale 19,37,490 Less. Ending inventory (Tk.5.10 X 34,400) 1,75,950 Variable cost of goods sold 17,61,540 Variable operating costs (Tk.1.10 X 345,400) 3,79,940 Total variable costs at standard costs 21,41,480 Adjustment for variances ______0 Total variable costs Contribution margin Fixed costs: Fixed manufacturing overhead cost 14,40,000

Taka 75,98,800

21,41,480 54,57,320

24


Fixed operating costs Adjustment for fixed cost variances Total fixed costs Operating income

10,80,000 ______0 25,20,000 29,37,320

*No. of units manufactured = (No. of units sold + Ending inventory) – Beginning inventory = (3,45,400 + 34,500) – 85,000 = 2,94,900 units (b) Absorption costing data: Fixed manufacturing overhead allocation rate Fixed manufactur ing overhead = Deno min ator level machine hours Tk.14,40,000 = 6,000 = Tk.240 per machine hour Fixed manufacturing overhead allocation rate per unit Fixed manufactur ing overhead allocation rate = S tan dard production rate Tk.240 = 50 = Tk.4.80 per unit Mosaj & Associates Income statement for the year ended December 31, 2017 Under absorption costing Particulars Taka Revenues (Tk.22 X 345,400) Cost of goods sold: Beginning inventory (Tk.5.10 + Tk.4.80) X 85,000 8,41,500 Add. Variable manufacturing costs (Tk.5.10 X 294,900) 15,03,990 Add. Fixed manufacturing costs (Tk.4.80 X 294,900) 14,15,520 Cost of goods available for sale 37,61,010 Less. Ending inventory (Tk.5.10 + Tk.4.80) X 34,400 3,41,550 Adjustment for manu. variances (Tk.4.80 X 5,100**) 24,480 Cost of goods sold Gross margin Operating costs: Variable operating costs (Tk.1.10 X 3,45,400) 3,79,940 Fixed operating costs 10,80,000 Adjustment for operating cost variances ______0 Total operating costs Operating income **(6,000 hours X 50) – 294,900 = 5,100 25

Taka 75,98,800

34,43,940 41,54,860

14,59,940 26,94,920


(c) Mosaj & Associates operating income in percentage terms: Under marginal costing: Revenues Operating income Pre-tax profit margin

Tk.75,98,800 Tk.29,37,320 38.66%

Under absorption costing: Revenues Operating income Pre-tax profit margin

Tk.75,98,800 Tk.26,94,920 35.46%

(d) Operating income using marginal costing is about 9% higher than the operating income calculated using absorption costing. Marginal costing operating income – Absorption costing operating income = Tk.29,37,320 – Tk.26,94,920 = Tk.2,42,400 Fixed manufacturing costs in beginning inventory under absorption costing – Fixed manufacturing costs in ending inventory under absorption costing = (Tk.4.80 X 85,000) – (Tk.4.80 X 34,500) = Tk.2,42,400 (e) I would recommend the marginal costing method to CFO since absorption costing has many criticizes. However, the dysfunctional aspects associated with absorption costing can be reduced by: - careful budgeting and inventory planning - adding a capital charge to reduce the incentives to build up inventory, and - monitoring non-financial performance measures P-6. The following budgeted information relates to Olympic Company Limited for the quarter ended September, 2017: Units Taka Production 14,000 Fixed Production costs 63,000 Sales 12,000 Fixed Selling costs 12,000 The normal level of activity is 14,000 units per quarter. Using marginal costing the profit for next period has been calculated as Tk.27,000. What would be the profit for the next quarter using absorption costing? Solution: Calculation of ending inventory: Beginning inventory Add. Production Less. Sales Ending inventory

Units 0 14,000 14,000 12,000 2,000 26


Tk.63,000 14,000 units = Tk.4.5 per unit

Fixed manufacturing overhead absorption rate =

Absorption costing includes fixed manufacturing overhead rather than charging them against profit: Profit under marginal costing Tk.27,000 Add. Fixed manufacturing overhead cost deferred in inventory under absorption costing (2,000 units X Tk.4.5) Tk.9,000 Profit under absorption costing Tk.36,000 P-7. Saad Company manufactures a special product that sells each unit for Tk.2,000 and the material cost per unit is Tk.1,000. Labour and variable overhead are Tk.1,600 and Tk.1,400 per week respectively. Fixed manufacturing costs are Tk.384,000 per annum and marketing and administrative costs are Tk.150,000 per annum. The products are made on three different machines. Machine X makes the four frame panels which are required for each special product. Its maximum output is 160 frame panels per week. Machine X is old and unreliable and it breaks down from time to time. It is estimated that, on average, between 15 to 20 hours of production are lost per month. Machine Y can manufacture parts for 40 special products per week and Machine Z, which is old but reasonably reliable, can process and assemble 20 special products per week. The company has recently introduced a just-in-time production system and it is a company policy to hold little work-in-process and no finished goods inventory from week to week. The company operates a 40 hours week, 48 weeks a year (12 months X 4 weeks). Required: Calculate the throughput accounting ratio for the key resource for an average hour next year. Solution: Output of Machine X: Up to 5 hours (20 hours lost per month รท 4 weeks per month) production time lost per week = One eight (40 hours per week รท 5 hours lost per week) of maximum production time per week 7 160 X 8 4 = 35 special products

Output =

Output of Machine Y: Parts for 40 special products Output of Machine Z: Process and assemble 20 special products Therefore, the key resource is Machine Z time.

27


Throughput contribution = Sales price – Material cost = Tk.2,000 – Tk.1,000 = Tk.1,000 40 hours per week 20 = 2 hours per special product

Time on key resource =

Tk.1,000 2 hours = Tk.500

Throughput contribution per factory hour =

Conversion cost per factory hour Labour cos t  Variable overhead  Fixed manufactur ing cos ts = Hours required per week Tk.1,600  Tk.1,400  Tk.8,000 Tk.384,000 = [Here, = Tk.8,000] 40 hours per week 48 weeks Tk.11,000 = 40 hours per week = Tk.275 Tk.500 Tk.275 = 1.82

Throughput accounting ratio =

P-8. Expert Company is involved in the processing of sheet metal into products X and Y using two processes, pressing and rolling. Like many business, Expert faces tough competition in what is a mature world market. The factory has 100 production lines each of which contain the two processes: raw material for the sheet metal is first pressed then finally rolled. The processing capacity varies for each process and the factory manager has provided the following data: Processing time per meter in hours Product X Product Y Pressing 1.00 0.90 Rolling 0.80 0.50 The factory operates for 16 hours each day for five days per week. It is closed for only two weeks of the year for holidays when maintenance is carried out. On average one hour of labour is needed for each of the 300,000 hours of factory time. Labour is paid Tk.20 per hour. The raw materials cost per meter is Tk.6.00 for product X and Tk.5.00 for product Y. Other factory costs (excluding labour and raw materials) are Tk.20,000,000 per year. Selling prices per meter are Tk.140 for product X and Tk.70 for product Y. It is the policy of Expert Company to carry out very little inventory.

28


Required: (a) Identify the bottleneck process and briefly explain why this process is described as „bottleneck‟? (b) Calculate the throughput accounting ratio for each product assuming that bottleneck process is fully utilized. (c) Assuming that the throughput accounting ratio of product Y is less than 1: (i) Explain how Expert could improve the throughput accounting ratio of product Y. (ii) Briefly discuss whether this supports the suggestion to cease the production of product Y and can briefly outline three other factors that Expert should consider before a cessation decision is taken. Solution: (a) Output capacity for each process: Total processing hours for the factory = 300,000 Product X 300,000 300,000 Pressing ( , ) 1.00 0.90 300,000 300,000 Rolling ( , ) 0.80 0.50

Product Y

300,000

333,333

375,000

600,000

Bottleneck process is the process which has a lower output capacity for all processes. Here, pressing has a lower output capacity. This means that pressing acts as a limiting factor and will constrain throughput. (b) Throughput accounting ratios =

Re turn per factory hour Total conversion cos t per factory hour

Here, Conversion cost = Labour costs + factory costs = (300,000 hours X Tk.20) + Tk.20,000,000 = Tk.6,000,000 + Tk.20,000,000 = Tk.26,000,000

Tk.26,000,000 300,000 hours = Tk.87 Return per factory hour = Sales – Direct costs or usage of bottleneck resource in hours Conversion cost per factory hour =

Selling price per meter Raw material cost per meter Return Usage of bottleneck resource in hours Return per factory hour Conversion cost per factory hour Throughput accounting ratios 29

Product X Tk. 140 6.00 134 1.00 134 87 1.54

Product Y Tk. 70 5.00 65 0.90 72 87 0.83


(c) (i) Way to improve the throughput accounting ratio of product Y: - Increase the selling price. - Reduce material costs. - Reduce factory costs. (ii) Ceasing the production of product Y: Product Y has lower throughput accounting ratio and it is below 1. This means that it incurs factory costs quicker than it generates throughput and is losing money every time it is being produced. Expert should therefore consider ceasing the production of product Y. Other factors should consider: - Customers who buy product X may also buy product Y. Ceasing of product Y may turn supplier to another if it is not available. - The costs and benefits from the production of product Y may be expected to change in the future. - Ceasing of product Y will create excess capacity and redundancy and machine scrap costs may be incurred if alternative uses for the excess capacity cannot be found. P-9. Safar Company uses a back-flush accounting system with three trigger points: * Purchase of direct materials * Completion of goods finished units of product * Sale of finished goods There are no beginning inventories. Information for April 2018 is: Direct material purchased Tk.88,00,000 Direct material used Tk.85,00,000 Conversion cost allocated Tk.40,00,000 Conversion cost incurred Tk.42,00,000 Cost transferred to finished goods Tk.1,25,00,000 Cost of goods sold Tk.1,19,00,000 Required: (a) Prepare journal entries for April (without disposing of underallocated or overallocated conversion costs). Assume there are no direct materials variances. (b) Under an ideal JIT production system, how would the amounts in your journal entries differ from the journal entries in requirement (a)? Solution: (a) Safar Company Journal entries For the month of April Si. No. i.

Particulars Inventory materials and in-process Accounts payable (direct materials purchased)

Dr. (Tk.) 88,00,000

Cr. (Tk.) 88,00,000

30


ii

iii.

iv.

Conversion costs Various accounts (conversion cost incurred) Finished goods Inventory materials and in-process Conversion cost allocated (standard cost of finished goods completed) Cost of goods sold Finished goods (standard cost of finished goods sold)

42,00,000 42,00,000 1,25,00,000 85,00,000 40,00,000 1,19,00,000 1,19,00,000

(b) Under an ideal JIT production system, if the manufacturing lead time per unit is very short, there could be zero inventories at the end of each day. Entry (iii) would be Tk.1,19,00,000 finished goods production [to match finished goods sold in entry (iv)], not Tk.1,25,00,000. If the marketing department could only sell goods costing Tk.1,19,00,000, the JIT production system would call for direct materials purchases and conversion costs of lower than Tk.88,00,000 and Tk.42,00,000, respectively in entries (i) and (ii).

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EXERCISES E-1. Bangladesh Transport Ltd. (BTL) is a renowned manufacturer and distributor of luxury cars, it has manufacturing facilities in Bangladesh with demand for its products in Europe. Two new innovative models has been introduced in recent year. These are the „R6‟ designed for normal luxury car and the „E10‟ which is SUV category. In a recent meeting Head of Operation (HOO) commented “we should produce more of the R6 cars as we can produce more compare to E10 in a year to earn more profit”. As a CFO you have to validate the assumption of HOO with supporting calculations. The following information relates to the year 2016: R6 (€) E10 (€) Selling price 20,000 28,000 Material cost 8,000 10,000 Variable production conversion costs 2,000 6,000 Fixed production overheads attributable to the manufacture of this two models will amount to €7 million. Expected demand for the year 2016 are 1,500 nos of R6 model Cars and 700 nos of E10 model SUVs. Each model is completed in the finishing department. The number of each type of vehicles that can be completed in one day in the finishing department is as follows: R6 7 units E10 6 units There are a total of 260 days available within the finishing department. The selling price for next year 2017 is expected to be 10% above the current year‟s price, whereas the variable cost and the total fixed costs are forecasted to be increased by 12% and 7% respectively above their current level. CFO declared that the profit target for next year should be increased by 10% than the maximum total profit can be earned in the year 2016. Required: (a) Using marginal costing principles, calculate the product mix of each type of cars which will maximize profitability of BTL with necessary calculation. Based on your calculation validate the comments of HOO. (b) Calculate the Throughput Accounting Ratio (TAR) for each type of vehicles and briefly discuss when it is worth producing a product where throughput accounting principles are in operations. You should use the variable overhead cost incurred as a result of the chosen product mix part (a) is fixed in the short-term. CMA Adapted – June 2017 E-2. PQS Ltd. produces two products, P and Q. The budgeted selling price per unit for P and Q are $3,600 and $4,320 respectively. Variable costs of production and sales for P and Q are $1,800 and $3,600 respectively. Annual fixed cost of the company amounts to $176,000. The company has two different production/sales options as under: Option 1- A mix of 2 units of P for every 3 units of Q Option 2- A mix of 1 unit of P for every 2 units of Q Find out the combined breakeven point under each option and the optimal mix that the company should adopt. CMA Adapted – June 2016

Contact us to collect exercises solution. Helpline: 01711137039 32


E-3. A Ltd. has been offered a choice to buy a machine between M1 and M2. The following data are provided: M1 M2 Annual output in units 10,000 10,000 Fixed Cost ($) 60,000 32,000 Profit as above level ($) 60,000 48,000 The market price of the product is expected to be $20 per unit. You are required to compute: (i) Breakeven point of each machine. (ii) The level of sales at which both the machines earn equal profit. (iii) The range of sales at which one is more profitable from the other. CMA Adapted – June 2016 E-4. H.M. Nahiyan & Co. manufactures and sells a single product. Cost data for the product are given below: Variable costs per unit: Direct material Direct labor Variable manufacturing overhead Variable selling and administrative Total variable cost per unit Fixed costs per month: Fixed manufacturing overhead Fixed selling and administrative Total fixed costs per month

Taka 7 10 5 3 25

315,000 245,000 560,000

The product sells for Tk.60 per unit. Production and sales data for July and August, the first two months of operations, follow: Units Produced Units Sold July 17,500 15,000 August 17,500 20,000 The companyâ€&#x;s Accounting Department has prepared absorption costing income statements for July and August as presented below: July August Sales 900,000 1,200,000 Less cost of goods sold: Beginning inventory 100,000 Add cost of goods manufactured 700,000 700,000 Goods available for sale 700,000 800,000 Less ending inventory 100,000 Cost of goods sold 600,000 800,000 Gross margin 300,000 400,000 Less selling and administrative expenses 290,000 305,000 Net operating income 10,000 95,000 33


Required: (i) Determine the unit product cost under Absorption costing and Variable costing. (ii) Prepare variable costing income statements for July and August using the contribution approach. (iii) Reconcile the variable costing and absorption costing net operating income figures. (iv) The company‟s Accounting Department has determined the company‟s break-even point to be 16,000 units per month, computed as follows: Fixed cos t per month Tk.560,000 = 16,000 units Unit contributi on m arg in, Tk.35 per month “I‟m confused,” said the president. “The accounting people say that our break-even point is Tk.16,000 units per month, but we sold only 15,000 units in July, and the income statement the prepared shows a Tk.10,000 profit for that month. Either the income statement is wrong or the break-even point is wrong.” Prepare a brief memo for the president, explaining what happened on the July income statement. CMA Adapted – August 2015 E-5. Rangpur Foundry Company Ltd. makes a replacement part (a plastic ring) for large plastic injection molding machines. Each machine requires four new rings a year. In 2013 and 2014, the company had the following standard costs for production of rings. Basic Production Data at Standard Cost Direct material Direct labor Variable manufacturing overhead Standard variable costs per ring

Tk.20.00 Tk.25.00 Tk.5.00 Tk.50.00

The annual budget for fixed manufacturing overhead (fixed factory overhead) is Tk.20,00,000.00. Expected (or budgeted) production is 2,00,000 rings per year, and the sales price is Tk.75.00. The single cost driver for the Tk.5.00 per ring variable manufacturing overhead is rings produced. Both budgeted and actual selling and administrative expenses are Tk.6,75,000.00 yearly fixed cost plus sales commission at 5% of sales. Actual product quantities are:

In units (rings), Opening inventory Production Sales Ending inventory

2013 1,70,000 1,40,000 30,000

2014 30,000 1,40,000 1,60,000 10,000

There are no variances from the standard variable manufacturing costs, and the actual fixed manufacturing overhead incurred is exactly Tk.20,00,000.00 each year. Required: (1) Prepare income statement for 2013 and 2014 under variable costing. (2) Prepare income statement for 2013 and 2014 under absorption costing. (3) Show a reconciliation of difference in operating income for 2013, 2014, and the two years. CMA Adapted – April 2015 34


E-6. “This makes no sense at all,” said H.M. Nahiyan, President of Keya Company. “We sold the same number of units this year as we did last year, yet our profits have more than doubled. Who made the goof- the computer or the people who operate it?” The statements to which Mr. Nahiyan was referring are shown below (absorption costing basis): Year 1 Year 2 Sales (20,000 units each year) Tk.700,000 Tk.700,000 Less cost of goods sold 460,000 400,000 Gross margin 240,000 300,000 Less selling and administrative expenses 200,000 200,000 Net operating income Tk.40,000 Tk.100,000 The statements above show the results of the first two years operations. In the first year, the company produced and sold 20,000 units; in the second year, the company again sold 20,000 units, but it increased produced as shown below: Year 1 Year 2 Production in units 20,000 25,000 Sales in units 20,000 20,000 Variable manufacturing cost per unit produced Tk.8 Tk.8 Variable selling and administrative expense per unit sold Tk.1 Tk.1 Fixed manufacturing overhead costs (total) Tk.300,000 Tk.300,000 Keya Company applies fixed manufacturing overhead costs to its only product on the basis of each year‟s production. (Thus, a new fixed manufacturing overhead rate is computed each year). Required: a) Compute the unit product cost for each year under: i) Absorption costing and ii) Variable costing b) Prepare a variable costing income statement for each year, using the contribution approach. c) Reconcile the variable costing and absorption costing net operating income figures for each year. d) Explain to the president why, under absorption costing, the net operating income for Year 2 was higher than the net operating income for Year 1, although the same number of units was sold in each year. e) i) Explain how operations would have differed in Year 2 if the company had been using JIT inventory method. ii) If JIT had been in use during Year 2, what would the company‟s net operating income have been under absorption costing? Explain the reason for any difference between this income figure and the figure reported by the company in the statements above. CMA Adapted – December 2014 E-7. Keya & Co. produces and sells a single product, a wooden hand loom for weaving small item such as scarves. Selected cost and operating data relating to the product for two years are given below: Year 1 Year 2 Units in beginning inventory 0 2,000 Units produced during the year 10,000 6,000 Units sold during the year 8,000 8,000 Units in ending inventory 2,000 0 35


Taka 50 11 6 3 120,000 5 70,000

Selling price per unit Direct material cost per unit Direct labor cost per unit Variable manufacturing overhead cost per unit Fixed manufacturing overhead cost per year Variable selling and administrative cost per unit sold Fixed selling and administrative costs per year Required: (i) Prepare an income statement for each year assuming that the company uses absorption costing. (ii) Prepare an income statement for each year assuming that the company uses variable costing. (iii) Reconcile the variable costing and absorption costing net operating income. CMA Adapted – August 2014 E-8. Advanced Technology Ltd. has started a new division to manufacture and sell specially designed tables for personnel computers. The Companyâ€&#x;s new plant is highly automated and thus requires high monthly fixed cost. Production cost: Variable cost per unit: Direct materials Tk.1,860.00 Variable manufacturing costs Tk.40.00 Fixed manufacturing costs Tk.24,00,000.00 Selling and administrative cost: Variable 15% of sales Fixed (total) Tk.16,00,000.00 The company regards all of its workers as a full-time employees and has a long-standing no lay-off policy. Furthermore, production is highly automated. Accordingly, the company has included in its fixed manufacturing overhead costs all its labour costs. During the first month of operation, the following activity was recorded. Units produced 4,000.00 Units sold 3,200.00 Units selling price Tk.4,500.00 Required: 1) Compute the unit product cost under (a) Absorption costing (b) Variable costing. 2) Prepare an income statement for the month using absorption costing. 3) Prepare an income statement for the month using variable costing. 4) Reconcile the profits reported under two methods. CMA Adapted – April 2014 E-9. Slim and Trim produces frozen youghurt, a low-fat dessert. The product is sold in five litre containers and had the following price and variable costs per unit in the current year. Selling price $27.00 Direct material 9.00 Direct labour 3.60 Variable overhead 5.40 36


Budgeted fixed overhead for the current year was $600,000, which was equal to actual fixed overhead. Actual production was 150,000 five-litre containers, which was equal to the budgeted level of production, but only 125,000 containers were sold. Slim and Trim incurred the following selling and administrative expenses: Fixed $100,000 Variable $2 per container sold. Required: (i) Calculate the cost per unit under variable and absorption costing. (ii) Prepare income statements for the current year using: (a) Absorption costing; (b) Variable costing. (iii) Reconcile the profits reported under the two methods. CMA Adapted – August 2013 E-10. The following data have been extracted from the budgets and standard costs of ABC Limited, a company which manufactures and sells a single product. Per unit Tk. Selling Price 45.00 Direct material cost 10.00 Direct wages cost 4.00 Variable overhead cost 2.50 Fixed production overhead cost are budgeted at Tk.400,000 per annum. Normal production levels are thought to be 320,000 units per annum. Budgeted selling and distribution cost are as follows: Variable Tk.1.50 per unit sold Fixed Tk.80,000 per annum Budgeted administration cost are Tk.120,000 per annum. The following pattern of sales and production is expected during the first six months of the year: January-March April-June Sales (units) 60,000 90,000 Production (units) 70,000 100,000 There is to be stock on 1 January. You are required (i) to prepare profit statements for each of the two quarters, in a column format using - Marginal costing, and - Absorption costing; (ii) to reconcile the profits reported for the quarter January-March in your answer to (a) above. CMA Adapted – April 2013

37


E-11. HP Hydroelectric Plant Company Ltd. to supply power, light and heat. It is end of 2011. The All Fixed Company began operations in January, 2010. The company has no variable costs. All of its costs are fixed; they do not vary with output. The All Fixed Company is located on the banks of a river and has its own hydroelectric plant to supply power, light and heat. The company manufactures a synthetic fertilizer from air and river water and sells its product at a price which is not expected to change. It has a small staff, all hired on an annual salary basis. The output of the plant can be increased or decreased by adjusting dials on a control panel. The following are data regarding the operations of the All Fixed Company: 2010 2011 Sales 10,000 tones 10,000 tones Production 20,000 tones Selling price Tk.300.00 per ton 3 00.00 per ton Production costs (fixed) Tk.28,00,000 Tk.28,00,000 General and administrative expense Tk.4,00,000 Tk.4,00,000 Required: (i) Prepare an income statement for the month using absorption costing method. (ii) Prepare an income statement for the month using variable costing method. (iii) What inventory costs would be carried in the balance sheets in December 2010 and 2011 under each method? CMA Adapted – April 2012 E-12. Smart Company on January 1, 2008 decides to convert with another company to preassemble a large percentage of the component of its telescopes. The revised manufacturing cost structure during the 2008 to 2010 period is: Variable manufacturing cost per unit produced: Direct material cost Direct manufacturing labour cost Indirect manufacturing cost Total variable manufacturing cost per unit produced Total fixed manufacturing cost (all indirect)

Tk.30.50 2.00 1.00 Tk.33.50 Tk.1,200

Under the revised cost structure, a large percentage of SMARTâ€&#x;s manufacturing costs are variable with respect to units produced. The denominator level of production used to calculate budgeted fixed manufacturing cost per unit in 2008, 2009 and 2010 is 800 units. Summary information pertaining to absorption costing operation income and variable costing operating income with this revised cost structure is given below: Particulars Absorption-costing operating income Variable-costing operating income Difference Beginning inventory Ending inventory

2008 Tk.16,800 16,500 300 200 units

2009 Tk.18,650 18,875 (225) 200 units 50 units

2010 Tk.24,000 23,625 375 50 units 300 units

38


Required: (i) Compute the budgeted fixed manufacturing overhead cost per unit in 2008. 2009 and 2010. (ii) Explain the difference between absorption-costing operating income and variablecosting operating income in 2008, 2009 and 2010, focusing on fixed manufacturing costs in beginning and ending inventory. CMA Adapted – December 2011 E-13. Far East Telecom Ltd. has organized a new division to manufacture and sell mobile telephones. Monthly costs associated with the mobile phones and with the plant in which the mobile phones are manufactured are as shown below: Manufacturing costs: Variable cost per unit: Direct Materials Variable manufacturing overheads Fixed manufacturing overheads

Tk.48.00 Tk.2.00 Tk.360,000

Selling and administrative costs: Variable Fixed (Total)

12% of sale Tk.4,70,000

Far East Telecom regards all of its workers as full time employees and the company has a long standing no layoff policy. Furthermore, production is highly automated. Accordingly, the company has included in its fixed manufacturing overheads all of its labor costs. The mobile phones sell for Tk.150 each. During, September, the first month of operations, the following activity was recorded: Unit produced Units sold

12,000 10,000

Required: (i) Prepare an income statement for the month using absorption costing. (ii) Prepare an income statement for the month using variable costing. (iii) Reconcile the absorption costing & variable costing net income, varies if any. CMA Adapted – August 2011 E-14. Green Power Company makes a replacement part (a plastic ring) for large plastic injection molding machines. Each machine requires four new rings a year. In 2009 and 2010, the company had the following standard costs for production of rings were as follows: Basic Production Data at Standard Cost Direct material Tk.13.00 Direct labor Tk.15.00 Variable manufacturing overhead Tk.2.00 Standard variable costs per ring Tk.30.00

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The annual budget for fixed manufacturing overhead (fixed factory overhead) is Tk.15,00,000 only. Expected (or budgeted) production is 1,50,000 rings per year, and sales is Tk.50.00. The single cost driver for the 2.00 per ring variable manufacturing overhead is rings produced. Both budgeted and actual selling and administrative expenses are Tk.6,50,000, yearly fixed cost plus sales commission at 5% of sales. Actual product quantities are: Details 2009 2010 In units (rings), Opening inventory 30,000 Production 1,70,000 1,40,000 Sales 1,40,000 1,60,000 Ending inventory 30,000 10,000 There are no variances from the standard variable manufacturing costs, and the actual fixed manufacturing overhead incurred is exactly Tk.15,00,000 each year. Required: (i) Prepare income statement for 2009 and 2010 under variable costing. (ii) Prepare income statement for 2009 and 2010 under absorption costing. (iii) Show a reconciliation of difference in operating income for 2009, 2010, and the two years as a whole. CMA Adapted – April 2011 E-15. Samir Telecom Limited of Dhaka has organized a new division to manufacture and sell cellular telephones. Monthly costs associated with the mobile phones and with the plant in which the mobile phones are manufactured are as shown below: Manufacturing costs: Variable cost per unit: Direct Materials Variable manufacturing overheads Fixed manufacturing overheads

Tk.48 Tk.2 Tk.360,000

Selling and administrative costs: Variable Fixed (Total)

12% of sale Tk.4,70,000

Samir Telecom regards all of its workers as full time employees and the company has a long standing no layoff policy. Furthermore, production is highly automated. Accordingly, the company has included in its fixed manufacturing overheads all of its labor costs. The mobile phones sell for Tk.150 each. During, September, the first month of operations, the following activity was recorded: Unit produced Units sold

12,000 10,000

Required: 1. Compute the unit product cost under: (i) Absorption costing. (ii) Variable costing. 2. Prepare an income statement for the month using absorption costing. 40


3. Prepare an income statement for the month using variable costing. 4. Assume that the company must obtain additional financing in order to continue operations. As a member of top management, would you prefer to take the statement in (2) above or in (3) above with you as you meet with a group of prospective investors? 5. Reconcile the net income figure in (2) and (3) above for September under absorption costing and variable costing. CMA Adapted – December 2010 E-16. Ovi Manufacturing Co. is interested in comparing net earnings for two periods. The company‟s operating data are as follows: Period-1 Period-2 Standard Production (units) 30,000 30,000 Actual Production (units) 30,000 25,000 Sales (units) 25,000 30,000 Sales price per unit Tk.15.00 Tk.15.00 Variable manufacturing costs per unit: Direct materials Tk.1.50 Tk.1.50 Direct labor 2.50 2.50 Variable factory overhead 2.00 2.00 Total variable manufacturing costs per unit Tk.6.00 Tk.6.00 Fixed factory overhead (Tk.4 per unit) Tk.120,000.00 Tk.120,000.00 Selling and administrative overhead (fixed) Tk.50,000.00 Tk.60,000.00 Required: (a) Prepare a statement of earnings for both periods under the: (1) Absorption costing method, (2) Direct costing method. (b) Account for difference in net earnings between the two methods. (c) Explain why net earnings under the two methods for the two periods are equal combindly. (d) If the firm used direct costing in its formal accounting records, what adjustments are necessary for external reporting? CMA Adapted – December 2009 E-17. Company A produces a single product with the following budget: Single price Tk.10 Per Unit Direct Materials 3 ,, ,, Direct wages 2 ,, ,, Variable overhead 1 ,, ,, Fixed overhead Tk.10,000 Per month The fixed overhead absorption rate is based on a volume of 5000 units per month. During the month of June 2009 production was 4800 units and sales were 4500 units. The company has no beginning inventory. Required: (i) Show the operating statement for the month under: - Absorption costing and - Direct costing (ii) Reconcile the difference in reported profit. CMA Adapted – August 2009 41


CHAPTER - 2 VARIANCE ANALYSIS

2.1. DEFINITION OF VARINACE ANALYSIS Variance analysis, in budgeting (or management accounting in general), is a tool of budgetary control by evaluation of performance by means of variances between budgeted amount, planned amount or standard amount and the actual amount incurred/sold. 2.2. TYPES OF VARIANCE ANALYSIS Materials total variance: The materials total variance is the difference between the actual cost of direct material and the standard material cost to the actual production. Material total variance = (Actual quantity bought × Actual Price) – (Standard quantity used for actual production × Standard Price) Materials price variance: Material price variance is the difference between the standard cost and the actual cost for the actual quantity of material purchased. Material Price Variance = (Actual quantity bought × Actual Price) – (Actual quantity bought × Standard Price) Materials usage variance: Material usage variance is the difference between the actual and expected unit quantity needed to manufacture a product. Material Usage Variance = (Actual quantity used × Standard Price) – (Standard quantity used for actual production × Standard Price) Labour total variance: The labour total variance is the difference between the actual cost of labour and the standard direct labour cost of the actual production. Labour total variance = (Actual hours required × Actual Rate) – (Standard hours required for actual production × Standard Rate) Labour rate variance: Labor variances are the differences between the planned and actual costs of labor as they relate to a project. Labour rate variance = (Actual hours required × Actual Rate) – (Actual hours required × Standard Rate)

42


Labour efficiency variance: Labour efficiency variance is the measure of difference between the standard cost of actual number of direct labour hours utilized during a period and the standard hours of direct labour for the level of output achieved. Labour efficiency variance = (Actual hours required × Standard Rate) – (Standard hours required for actual production × Standard Rate) Variable overhead total variance: It is normally assumed that variable overheads vary with direct labour hours of input and the variable overhead total variance will therefore be due to one of the following: - the variable overhead cost per hour was different to that expected (an expenditure variance) - working more or fewer hours than expected for the actual production (an efficiency variance) Variable overhead total variance = (Actual variable overhead – (Standard hours required for actual production × Variable overhead Rate) Variable overhead expenditure variance: Variable overhead expenditure variance is the difference between variable production overhead expense incurred during a period and the standard variable overhead expenditure. The variance is also referred to as variable overhead rate variance and variable overhead spending variance. Variable overhead expenditure variance = (Actual variable overhead rate − Standard variable overhead rate) × Actual hours Variable overhead efficiency variance: The variable overhead efficiency variance is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour. Variable overhead efficiency variance = (Actual hours - Standard hours) X Standard overhead rate Sales price variance: The sales price variance shows the effect on profit of selling at a different price from that expected. Sales price variance = (Actual Price – Budget Price) × Actual Quantity sold If the actual price is greater that the budget this will produce a favourable variance as it increases profit. Sales revenue/ margin volume variance: The sales margin volume variance calculates the effect on profit of the actual sales volume being different from that budgeted. 43


Sales margin volume variance = (Actual Quantity Sold – Budget Quantity sold) × Standard Margin If the actual quantity sold is greater that the budget this will produce a favourable variance as it increases profit. 2.3. MEANING OF STANDARD COSTING Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records, and then periodically recording variances showing the difference between the expected and actual costs. 2.4. REASONS FOR USING STANDARD COSTING One reason for a manufacturer to use standard costing is to plan carefully what its costs will be for the upcoming budgeting year and to then compare the actual costs with those planned costs. If the actual costs are similar to the standard costs (the planned costs; what the costs should be) the company is on track to reach the cost part of its profit plan. If the actual costs deviate from the standard costs, management is alerted by the variances that are reported for materials, labor and manufacturing overhead. Hence standard costs allow a manufacturer to practice management by exception. That is, if the actual costs are what they should be, management action is not required. If the actual costs are more than the standard costs, management must take action or it will not achieve the planned profit. 2.5. STANDARD COST AND STANDARD COST CARD A standard cost is the planned unit cost of a product or service. It is an indication of what a unit of product or service should cost. Standard costs represent „target‟ costs and they are therefore useful for planning, control and motivation. Standard cost card is a detailed listing of the standard amounts of materials, labor, and overhead that should go into a unit of product, multiplied by the standard price or rate that has been set for each cost element. 2.6. TYPES OF COST STANDARDS (a) Basic standards – these are long-term standards which remain unchanged over a period of years. Their sole use is to show trends over time for items such as material prices, labour rates, and labour efficiency. (b) Ideal standards – these standards are based upon perfect operating conditions. Perfect operating conditions include: no wastage; no scrap; no breakdowns; no stoppages; no idle time. Ideal standards may have an adverse motivational impact because they are unlikely to be achieved. (c) Attainable standards – these standards are the most frequently encountered type of standard. They are based upon efficient operating conditions. These standards include allowances for the following: normal or expected material losses; fatigue; machine breakdowns.

44


(d) Current standards – these standards are based on current levels of efficiency in terms of allowances for breakdowns, wastage, losses and so on. The main disadvantage of using current standards is that they do not provide any incentive to improve on the current level of performance. 2.7. ADVANTAGES OF STANDARD COSTING (a) Standard Costing serves as a guide to the management in several management functions while formulating prices and production policies etc. (b) More effective cost control is possible under standard costing if the same is reviewed and analysed at regular intervals for improvements and immediate action can be taken if deviations from standards are found out which, ultimately, leads to cost reduction. (c) Analysis of variance and its measurement helps to detect inefficiencies and mistakes which enable the management to investigate the reasons. (d) Since standard costs are predetermined costs they are very useful for planning and budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship which also helps the management for decision-making in future. (e) As standard is fixed for each product, its components, materials, process operation etc. it improves the overall production efficiency which also ultimately reduces cost and thereby increases profit. 2.8. DISADVANTAGES OF STANDARD COSTING (a) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As such, small organisations cannot, introduce the system due to their limited financial resources. But, once introduced, the benefits achieved will be far in excess to its initial high costs. (b) The executives are liable for those variances that are found from actions which are actually controllable by them. Thus, in order to fix up the responsibilities, it becomes necessary to segregate variances into non-controllable and controllable portions although that is not an easy task. (c) Standards are always changing since conditions of the business are equally changing. So, standards are to be revised in order to make them comparable with actual results. But revision of standards creates many problems, particularly in inventory adjustment. (d) Standards are either too liberal or rigid since the same are based on average past results, attainable good performance or theoretical maximum efficiency. So, if the standards are very high, it will adversely affect the morale and motivation of the employees.

45


USEFUL FORMULAS 1. Material total variance = (Actual quantity bought × Actual Price) – (Standard quantity used for actual production × Standard Price) 2. Material price variance = (Actual quantity bought × Actual Price) – (Actual quantity bought × Standard Price) 3. Material usage variance = (Actual quantity used × Standard Price) – (Standard quantity used for 4. Labour total variance = (Actual hours required × Actual Rate) – (Standard hours required for actual production × Standard Rate) 5. Labour rate variance = (Actual hours required × Actual Rate) – (Actual hours required × Standard Rate) 6. Labour efficiency variance = (Actual hours required × Standard Rate) – (Standard hours required for actual production × Standard Rate) 7. Variable overhead total variance = (Actual variable overhead – (Standard hours required for actual production × Variable overhead Rate) 8. Variable overhead expenditure variance = (Actual variable overhead rate − Standard variable overhead rate) × Actual hours 9. Variable overhead efficiency variance = (Actual hours - Standard hours) X Standard overhead rate 10. Sales price variance = (Actual sales price – Standard sales price) X Actual sales units 11. Sales volume variance under absorption costing = (Actual sales units – Standard sales units) X Budgeted unit profit 12. Sales volume variance under marginal costing = (Actual sales units – Standard sales units) X Budgeted unit contribution

46


PROBLEMS AND SOLUTIONS P-1. The following information relates to the production of Product X. Extract from the standard cost card of Product X: Direct materials (40 square metres × Tk.5.30 per square metre) Tk.212. Actual results for direct materials in the period: 1,000 units were produced and 39,000 square metres of material costing Tk.210,600 in total were used. Required: Calculate the materials total, price and usage variances for Product X in the period. Solution: Material total variance = (Actual quantity bought × Actual Price) – (Standard quantity used for actual production × Standard Price) = Tk.210,600 - (1,000 X 40 X Tk.5.30) = Tk.210,600 – Tk.212,000 = Tk.1,400 Fav. Material price variance = (Actual quantity bought × Actual Price) – (Actual quantity bought × Standard Price) = Tk.210,600 - (39,000 X Tk.5.30) = Tk.210,600 – Tk.206,700 = Tk.3,900 Adv. Material usage variance = (Actual quantity used × Standard Price) – (Standard quantity used for actual production × Standard Price) = (39,000 X Tk.5.30) – (1,000 X 40 X Tk.5.30) = Tk.206,700 – Tk.212,000 = Tk.5,300 Fav. P-2. The following information relates to the production of Product X. Extract from the standard cost card of Product X: Direct labour: Bonding (24 hrs @ Tk.5 per hour)

Tk.120

Actual results for wages: Production 1,000 units produced Bonding 23,900 hours costing

Tk.131,450 in total

Required: Calculate the labour total, rate and efficiency variances in the Bonding department for Product X in the period.

47


Solution: Labour total variance = (Actual hours required X Actual Rate) – (Standard hours required for actual production X Standard Rate) = Tk.131,450 - (1,000 X 24 X Tk.5) = Tk.131,450 – Tk.120,000 = Tk.11,450 Adv. Labour rate variance = (Actual hours required X Actual Rate) – (Actual hours required X Standard Rate) = Tk.131,450 - (23,900 X Tk.5) = Tk.131,450 – Tk.119,500 = Tk.11,950 Adv. Labour efficiency variance = (Actual hours required X Standard Rate) – (Standard hours required for actual production X Standard Rate) = (23,900 X Tk.5) – (1,000 X 24 X Tk.5) = Tk.119,500 – Tk.120,000 = Tk.500 Fav. P-3. The following information relates to the production of Product X. Extract from the standard cost card of Product X: Tk. Direct labour: Bonding Variable overhead: Bonding (24 hrs @ Tk.1.50 per hour)

120 36

Actual results for production and labour hours worked: Production 1,000 units produced Bonding 23,900 hours Actual results for variable overheads: Bonding total cost Tk.38,240 Required: Calculate the variable overhead total, expenditure and efficiency variances in the Bonding department for Product X for the period. Solution: Variable overhead total variance = Actual variable overhead – (Standard hours required for actual production × Variable overhead Rate) = Tk.38,240 - (1,000 X 24 X Tk.1.5) = Tk.38,240 – Tk.36,000 = Tk.2,240 Adv. 48


Variable overhead expenditure variance = (Actual variable overhead rate − Standard variable overhead rate) × Actual hours = (Tk.1.6 - Tk.1.5) X 23,900 hours = Tk.0.1 X 23,900 hours = Tk.2,390 Adv. Variable overhead efficiency variance = (Actual hours - Standard hours) X Standard overhead rate = (23,900 – 24,000) X Tk.1.5 = 100 X Tk.1.5 = Tk.150 Fav. P-4. The following data relates to 2017. Actual sales: Budgeted output and sales for the year: Standard selling price: Budgeted contribution per unit: Budgeted profit per unit:

1,000 units @ Tk.650 each 900 units Tk.700 per unit Tk.245 Tk.205

Required: Calculate the sales price variance and sales margin volume variance (under absorption and marginal costing). Solution: Sales price variance = (Tk.650 – Tk.700) X 1,000 units = Tk.50,000 Adv. Sales margin volume variance under absorption costing = (1,000 units – 900 units) X Tk.205 = Tk.20,500 Fav. Sales margin volume variance under marginal costing = (1,000 units – 900 units) X Tk.245 = Tk.24,500 Fav. P-5. The following information is given for BKB Ltd. during September: Standard margin on budgeted sales Standard margin on actual sales Standard margin on standard sales Actual margin on actual sales

Tk.38,000 Tk.38,600 Tk.38,380 Tk.34,780

You are required to(a) Calculate the sales margin variance for September; (b) Prepare a statement reconciling budget margin with actual margin.

49


Solution: (a) Total sales margin variance: Standard margin on budgeted sales Actual margin on actual sales

Tk.38,000 Tk.34,780 Tk.3,220 UF

Sales margin price variance: Standard margin on actual sales Actual margin on actual sales

Tk.38,600 Tk.34,780 Tk.3,820 UF

Sales margin volume variance: Standard margin on budgeted sales Standard margin on actual sales

Tk.38,000 Tk.38,600 Tk.600 F

Sales margin mix variance: Standard margin on actual sales Standard margin on standard sales

Tk.38,600 Tk.38,380 Tk.220 F

Sales margin quantity variance: Standard margin on budgeted sales Standard margin on standard sales (b) Reconciliation statement: Budgeted sales margin Variances: Price variance Mix variance Quantity variance Actual sales margin

Tk.38,000 Tk.38,380 Tk.380 F Tk.38,000 Tk.3,820 UF 220 F 380 F

Tk.3,220 Tk.34,780

P-6. The sale budget of BKB Ltd. for September is as follows: Product P Q R S

Quantity 100 200 400 100

The Standard costs of the companyâ€&#x;s products are: P Q R S The sales for September were: Product P Q R S

Quantity 110 180 420 98

Selling price (Tk.) 200 150 100 300

140 120 60 200

Selling income (Tk.) 20,900 26,100 41,160 28,420 50


You are required to – (a) Calculate the sales margin variances for September; (b) Prepare a statement reconciling budget margin with actual margin; and (c) Append brief notes on the matters which you consider should receive the attention of management. Solution: (a) Budgeted margin per unit = Budgeted selling price – Standard cost P Tk.200 – Tk.140 Tk.60 Q Tk.150 – Tk.120 Tk.30 R Tk.100 – Tk.60 Tk.40 S Tk.300 – Tk.200 Tk.100 Actual margin per unit at purchase = Actual selling price* – Standard cost *Actual selling price per unit = Selling income ÷ Quantity sold P Q R S

Tk.190 – Tk.140 Tk.145 – Tk.120 Tk.98 – Tk.60 Tk.290 – Tk.200

Tk.50 Tk.25 Tk.38 Tk.90

Standard margin on standard mix P 100 units @ Tk.60 Q 200 units @ Tk.30 R 400 units @ Tk.40 S 100 units @ Tk.100 800 units

Tk.6,000 Tk.6,000 Tk.16,000 Tk.10,000 Tk.38,000

Standard margin on actual mix P 110 units @ Tk.60 Q 180 units @ Tk.30 R 420 units @ Tk.40 S 98 units @ Tk.100 808 units

Tk.6,600 Tk.5,400 Tk.16,800 Tk.9,800 Tk.38,600

Actual margin on actual mix P Q R S

110 units @ Tk.60 180 units @ Tk.30 420 units @ Tk.40 98 units @ Tk.100 808 units

Tk.5,500 Tk.4,500 Tk.15,960 Tk.8,820 Tk.34,780

(b) Reconciliation statement Total sales margin variance: Standard margin on budget sales Actual margin on actual sales Variance 51

Tk.38,000 34,780 Tk.3,220 A

Tk.3,220 A


Sales margin price variance: Standard margin on actual sales Actual margin on actual sales Variance

Tk.38,600 34,780 Tk.3,820 A

Sales margin volume variance: Standard margin on budget sales Standard margin on actual sales Variance

Tk.38,000 38,600 Tk.600 F

Sales margin mix variance: Standard margin on actual mix Standard margin on standard mix of 808 units 808 units X Tk.38,000 800 units Variance Sales margin quantity variance: Standard margin on budgeted sales Standard margin on standard mix of 808 units Variance

Tk.3,820 A

Tk.600 F

Tk.600 F Tk.3,220 A

Tk.38,600

38,380 Tk.220 F

Tk.38,000 Tk.38,380 Tk.380 F

Tk.220 F

Tk.380 F Tk.600 F

P-7. Rahim & Co. is a manufacturing company which processes and cans tomato catsup in 24 ounce jar. The standard input for a batch is as follows: Particulars Tomatoes Corn Syrup Vinegar Salt Onion powder Input Output

Pound 340 75 25 10 50 500 400

Standard price per pound (Tk.) 0.60 0.10 0.40 0.20 0.53

The recipe used not only is secret but also allows for some variation in ingredients in obtaining the special flavor. The following materials were purchased during the month. Direct materials inventory is kept as standard. Particulars Tomatoes Corn Syrup Vinegar Salt Onion powder

Pound 23,000 5,000 3,000 800 2,500

Actual cost (Tk.) 14,950 250 1,320 176 1,200

52


During the month 18,000 jars were filled with the following materials put in process: Particulars Tomatoes Corn Syrup Vinegar Salt Onion powder Total

Pound [16 ounce = 1 pound] 22,100 3,900 1,900 500 1,950 30,350

Required: (a) Compute materials purchase price variance for each of the material and material total mix and total yield variance for the month. Indicate if the variance is favorable or unfavorable. (b) Prepare journal entries to record the issuance of materials, the variance and the disposition of the variance. Solution: (a) Particulars

Pound

Tomatoes Corn Syrup Vinegar Salt Onion powder Input Output Standard cost of per pound of input (250 รท 500) Standard cost of per pound of output (250 รท 400)

340 75 25 10 50 500 400

Standard cost (Tk.) 204.00 7.50 10.00 2.00 26.50 250.00 0.50 0.625

Materials purchase price variance: Particulars

Tomatoes Corn Syrup Vinegar Salt Onion powder

Actual production

Standard price per pound (Tk.)

Actual price per pound (Tk.)

23,000 5,000 3,000 800 2,500

0.60 0.10 0.40 0.20 0.53

0.65 0.05 0.44 0.22 0.43

Here, UF = Unfavorable, F = Favorable

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Price variance per pound (Tk.) 0.05 UF 0.05 F 0.04 UF 0.02 UF 0.05 F Total

Total purchase price variance (Tk.) 1150 UF 250 F 120 UF 16 UF 125 F 911 UF


Materials mix variance: Particulars Tomatoes Corn Syrup Vinegar Salt Onion powder

Actual quantity 22,100 3,900 1,900 500 1,950 30,350

Standard price (Tk.) 0.60 0.10 0.40 0.20 0.53

Actual quantity at standard input cost (30,350 pounds X Tk.0.50) Unfavorable material mix variance Material yield variance: Actual quantity at standard input (30,350 pounds X Tk.0.50) Actual quantity at standard output cost (27,000* pounds X Tk.0.625) Unfavorable material yield variance

Amount (Tk.) 13260.00 390.00 760.00 100.00 1033.50 15543.50 15175.00 368.50

Tk.15175.00 Tk.16875.00 Tk.1700.00

18,000 jars X 24 ounce = 27,000 pounds 16 pounds (b) *

Si. No. i.

ii.

iii.

Particulars Direct materials Material purchase price variance Accounts payable Work-in-process Material mix variance Material yield variance Direct material Material yield variance Material mix variance Material purchase price variance Cost of goods sold

Dr. (Tk.) 16,985.00 911.00

Cr. (Tk.)

17,896.00 16875.00 368.50 1700.00 15543.50 1700.00 368.50 911.00 420.50

P-8. Nexus Corporation uses a standard cost system. Cement is produced by mixing two major components. A (Lime) and B (Clay), with water and by adding a third component, C quantitatively insignificant. Material standards and costs for the production of 100 tons of output are: Tons Cost Percent of Amount (Tk.) input quantity (Tk.) Material A 55 43 50% 2365 Material B 44 35 40% 1540 Material C 11 25 10% 275 Input 110 100% 4180 = Tk.38.00 per ton Output 100 4180 = Tk.41.80 per ton

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The monthly factory overhead budget for a normal capacity level of 16500 direct labor hours is as follows: Fixed overhead Variable overhead (Tk.) (Tk.) Plant Manager 2000 Supervisors 1800 Indirect labor 2220 810 Indirect supplies 850 2040 Power and light 300 2200 Water 480 2000 Repairs and maintenance 500 1200 Insurance 450 Depreciation – production facilities 3775 Total 12375 8250 To covert 110 tons of materials into 100 tons of finished cement requires 500 direct labor hours at Tk.7.50 per hour or Tk.37.50 per ton. Factory overhead is applied on a direct labor basis. In producing 3234 tons of finished cement in April, the following costs were incurred: Direct labor 15800 hours @ Tk.7.95 Fixed factory overhead Tk.11075 Variable factory overhead Tk.8490

Material A Material B Material C

Material purchased Quantity Cost per ton 2000 tons Tk.44 1200 tons Tk.37 500 tons Tk. 24 Total

Material requisitioned quantity 1870 tons 1100 tons 440 tons 3410 tons

There were no inventories of materials or work-in-process at the beginning of April. The materials price variance is recognized at the time of purchase. Required: (a) Compute the materials price, mix and yield variances. (b) Compute the direct labor rate, efficiency and yield variances. (c) Compute the factory overhead spending, idle capacity, efficiency and yield variances. Solution: (a) Material price variance: Materials A B C

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Materials purchased 2,000 1,200 500 3,700

Actual cost (Tk.) 88,000 44,400 12,000 144,400

Standard cost (Tk.) 86,000 42,000 12,000 140,500

Materials price variance (Tk.) 2,000 UF 2,400 UF (500) F 3,900 UF


Material mix variance: Materials

Materials requisitioned (Tons)

Actual input standard cost (Tk.)

Standard tons for unit

A

1,870

80,410

B

1,100

38,500

C

440

11,000

3,410

129,910

3410X50%= 1705 3410X40%= 1364 3410X10%= 341 3,410

Material yield variance: Input (3,410 tons to produce) Actual output Material yield gain Material yield variance Or, 3,100 tons @ Tk.41.80 3,234 tons @ Tk.41.80 Material yield variance

Standard tons input at standard cost (Tk.) 73,315

Material mix variance 7,095 UF

47,740

(9,240) F

8,525

2,475 UF

129,580

330 UF

3,100 tons 3,234 (134) tons @ Tk.41.80 Tk.(5,601) F Tk.129,580 Tk.135,181 Tk.(5,601) F

(b) Direct labor rate variance: Actual direct labor cost (15,800 hrs X Tk.7.95) Actual hours X Standard rate (15,800 hrs X Tk.7.50) Labor rate variance

Tk.125,610 Tk.118,500 Tk.7,110 UF

Direct labor efficiency variance: Actual hours X Standard rate (15,800 hrs X Tk.7.50) Input (3,410 tons รท 110 tons) X 500 DLH X Tk.7.50 Direct labor efficiency variance

Tk.118,500 Tk.116,250 Tk.2,250 UF

Direct labor yield variance: Input at expected output Actual output (3,234 tons X Tk.37.50) Direct labor yield variance

Tk.116,250 Tk.121,275 Tk.(5,025) F

(c) Factory overhead spending variance: Actual factory overhead: Fixed factory overhead Variable factory overhead

Tk.11,075 Tk.8,490 Tk.19,545

Budgeted allowance: Fixed factory overhead Variable overhead (15,800 actual hrs X Tk.0.50*) Spending variance * Tk.8,250 รท 16,500 hrs = Tk.0.50

Tk.12,375 Tk.7,900 Tk.20,275 Tk.(710) F

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Idle capacity variance: Budgeted allowance Applied factory overhead (Actual hrs 15,800 X Standard OH rate Tk.1.25**) Idle capacity variance ** (Fixed Tk.12,375 + Variable Tk.8,250) รท 16,500 hrs = Tk.1.25 standard overhead rate per hour Efficiency variance: Applied factory overhead Standard hrs allowed for input X Standard OH rate (3,410 tons X 500/110) = 15,500 hrs X Tk.1.25** Efficiency variance Yield variance: Standard hours allowed for input X Standard OH rate Standard hours for output (3,234 tons X 5*** hrs X Tk.1.25) Yield variance *** 500 hrs รท 100 tons = 5 hrs per ton

Tk.20,275 Tk.19,750 Tk.525 UF

Tk.19,750 Tk.19,375 Tk.375 UF

Tk.19,375 Tk.20,213 Tk.(838) F

P-9. K Ltd manufactures Product 20K. Information relating to this product is given below. Budgeted output for the year: 900 units Standard details for one unit: Direct materials: 40 square metres at Tk.5.30 per square metre Direct wages: Bonding department 24 hours at Tk.5.00 per hour Finishing department 15 hours at Tk.4.80 per hour Budgeted costs and hours per annum are as follows: Variable overheads: Bonding department Finishing department Fixed overheads: Production Selling, distribution and administration

Tk.

Hours

45,000 25,000

30,000 25,000

36,000 27,000

Variable overheads are recovered using hours, fixed overheads are recovered on a unit basis. Required: Prepare a standard cost card in order to establish the standard cost of one unit of Product 20K and enter the following sub-totals on the card: (a) Prime cost (b) Marginal cost (c) Total absorption cost (d) Total standard cost

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Solution: Standard cost card – Product 20k Tk. 212

Direct materials (40 X Tk.5.30) Direct labour: Bonding (24 hours X Tk.5.00) Finishing (15 hours X Tk.4.80) (a) Prime cost Variable overhead: Bonding (Tk.45,000 ÷ 30,000) X 24 hours Finishing (Tk.25,000 ÷ 25,000) X 15 hours (b) Marginal cost Production overheads (Tk.36,000 ÷ 900) (c) Total absorption cost Non-production overheads (Tk.27,000 ÷ 900) (d) Total standard cost

120 72 404 36 15 455 40 495 30 525

P-10. A company accountant has gathered together some cost information for his company‟s products as follows: Cost Direct materials Tk.4 per kilogram used Direct labour Tk.22 per hour worked Variable overheads Tk.6 for each hour that direct labour work He has also determined that fixed production overheads will be Tk.400,000 in total. Overheads are absorbed on a per unit basis. Investigation has shown that each unit of the product uses 3 kilogram of material and needs 2 hours of direct labour work. Sales and production were budgeted at 20,000 units, but only 16,000 were actually produced and 14,000 actually sold. There was no opening stock. Required: (a) Produce a standard cost card using absorption costing and value of the company‟s closing stock on that basis. (b) Produce a standard cost card using marginal costing and value of the company‟s closing stock on that basis. Solution: (a) Standard cost card using absorption costing: Direct materials (3 kgs X Tk.4) Direct labour (2 hrs X Tk.22) Variable overheads (2 hrs X Tk.6) Production overhead per unit (Tk.400,000 ÷ 20,000 units) Standard cost per unit

Tk. 12 44 12 20 88 58


Stock valuation: Value of the companyâ€&#x;s closing stock = 2,000 units X Tk.88 = Tk.176,000 (b) Standard cost card using marginal costing: Tk. 12 44 12 68

Direct materials (3 kgs X Tk.4) Direct labour (2 hrs X Tk.22) Variable overheads (2 hrs X Tk.6) Standard cost per unit Stock valuation: Value of the companyâ€&#x;s closing stock = 2,000 units X Tk.68 = Tk.136,000

P-11. Finix has produced the following operating statement reconciling budget and actual gross profit for the last four months, based on actual sales of 100,000 units of its single product: Operating statement Budgeted gross profit Budgeted fixed production overhead Budgeted contribution Sales volume contribution variance Sales price variance

Tk.

Tk.

Tk. 600,000 200,000 800,000

20,000 (80,000) (60,000) 740,000

Actual sales less standard variable cost of sales Planning variances Favourable Material 30,000 Labour

Adverse 100,000 (70,000)

Operational variances Material Labour

50,000 150,000 100,000 770,000

Actual contribution Budgeted fixed production overhead Fixed production overhead expenditure variance Actual fixed production overhead Actual gross profit

(200,000) 40,000 (160,000) 610,000

The standard direct costs and selling price applied during the four month period and the actual direct costs and selling price for the period were as follows: Standard Actual Selling price (Tk/unit) 40 38 Direct material usage (Kg/unit) 6 4 59


Direct material price (Tk/kg) Direct labour efficiency (Hrs/unit) Direct labour rate (Tk/hr)

4 2 10

5 3 11

After the end of four month period and prior to the preparation of the above operating statement, it was decided to revise the standard costs retrospectively to take account of the following: (a) A 5% increase in the direct material price per kilogram; (b) A labour rate increase of 6%; (c) The standard for labour efficiency had anticipated buying a new machine leading to a 10% decrease in labour hours; instead of buying a new machine, existing machines had been improved, giving an expected 7% saving in material usage. Required: (i) Calculate the revised standard costs. (ii) Using the information provided demonstrate how the planning and operational variances in the operating statement has been calculated. (iii) Explain the significance of separating variances into planning and operational elements and the problems which could arise. Solution: (i) Revised standard costs: Direct material price = 4 + (4 X 5%) = 4 + 0.2 = 4.20 Tk/kg Direct material usage = 6 - (6 X 7%) = 6 – 0.42 = 5.58 Kg/unit Direct labour rate = 10 + (Tk.10 X 6%) = 10 + 0.6 = 10.60 Tk/hr 100 Direct labour hours = 2 X 90 = 2.22 Hrs/unit (ii) Tk. Material Actual material costs (100,000 units X 4 kg X Tk.5) Revised standard costs (100,000 units X 5.58 kg X Tk.4.20) Total operational variance Revised standard costs Original standard costs (100,000 units X 6 kg X Tk.4) Total planning variance

2,000,000 2,343,600 343,600 F 2,343,600 2,400,000 56,400 F 60


Labour Actual labour costs (100,000 units X 3 hrs X Tk.11) Revised standard cost (100,000 units X 2.22 hrs X Tk.10.60) Total operational variance Revised standard cost Original standard costs (100,000 units X 2 hrs X Tk.10) Total planning variance

3,300,000 2,353,200 946,800 A 2,353,200 2,000,000 353,200 A

(iii) Significance of separating variances into planning and operational elements: A planning variance compares an original standard with a revised standard that would have used if planners had known in advance what was going to happen. Planning variances are uncontrollable by operational managers but can be avoided through better planning. An operational variance compares an actual result with the revised standard. Operational variances are controllable by managers. Problems which could arise: It is difficult to decide in hindsight what the realistic standard should have been and establishing retrospective standards is time consuming. P-12. “Wonderful! Not only did our salespeople do a good job in meeting the sales budget this year, but our production people did a good job in controlling costs as well,” said Kim Clark, president of Martell Company. “Our Tk.18,300 overall manufacturing cost variance is only 1.2% of the Tk.1,536,000 standard cost of products made during the year. That‟s well within the 3% parameter set by management for acceptance variances. It looks like everyone will be in line for a bonus this year.” The company produces and sells a single product. The standard cost card for the product follows: Standard Cost Card – per Unit of Product Direct materials, 2 feet at Tk.8.45 per foot Direct labor, 1.40 direct labor hours at Tk.16 per direct labor-hour Variable overhead, 1.40 direct labor hours at Tk.2.50 per direct labor-hour Fixed overhead, 1.40 direct labor hours at Tk.6 per direct labor-hour Standard cost per unit

Tk.16.90 22.40 3.50 8.40 Tk.51.20

The following additional information is available for the year just completed: (a) The company manufactured 30,000 units of product during the year. (b) A total of 64,000 feet of material was purchased during the year at a cost of Tk.8.55 per foot. All of this material was used to manufacture the 30,000 units. There were no beginning or ending inventories for the year. (c) The company worked 43,500 direct labor-hours during the year at a direct labor cost of Tk.15.80 per hour.

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(d) Overhead is applied to products on the basis of standard direct labor-hours. Data relating to manufacturing overhead costs follow: Denominator activity level (direct labor-hours) 35,000 Budgeted fixed overhead cost (from the overhead flexible budget) Tk.210,000 Actual variable overhead costs incurred Tk.108,000 Actual fixed overhead costs incurred Tk.211,000 Required: (a) Compute the direct materials price and quantity variances for the year. (b) Compute the direct labor rate and efficiency variances for the year. (c) For manufacturing overhead compute: (i) The variable overhead spending and efficiency variances for the year. (ii) The fixed overhead budget and volume variances for the year. (d) Total the variances you have computed, and compare the net amount with the Tk.18,300 mentioned by the president. Do you agree that bonuses should be given to everyone for good cost control during the year? Explain. Solution: (a) Direct materials price variance = AQ (AP – SP) = 64,000 feet (Tk.8.55 per foot – Tk.8.45 per foot) = Tk.6,400 UF Direct materials quantity variance = SP (AQ – SQ) = Tk.8.45 per foot (64,000 feet – 60000 feet*) = Tk.33,800 UF *30,000 units X 2 feet per unit = 60,000 feet (b) Direct labor rate variance = AH (AH – SH) = 43,500 DLHs (Tk.15.80 per DLH – Tk.16.00 per DLH) = Tk.8,700 F Direct labor efficiency variance = SR (AH – SH) = Tk.16.00 per DLH (43,500 DLHs – 42,000 DLFs*) = Tk.24,000 UF *30,000 units X 1.4 DLHs per unit = 42,000 DLHs (c) (i) Variable overhead spending variance = (AH X AR) – (AH X SR) = Tk.108,000 – (43,500 DLHs X Tk.2.50 per DLH) = Tk.750 F

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Variable overhead efficiency variance = SR (AH - SH) = Tk.2.50 per DLH (43,500 DLHs – 42,000 DLHs) = Tk.3,750 UF (ii) Fixed overhead budget variance = Actual fixed overhead cost – Flexible budget fixed overhead cost = Tk.211,800 – Tk.210,000 = Tk.1,800 UF Fixed overhead volume variance = Fixed portion of the predetermined overhead rate (Denominator hours – Standard hours allowed) = Tk.6.00 per DLH (35,000 DLHs – 42,000 DLHs) = Tk.42,000 F (d) Total of the variances would be: Direct materials variances: Price variance Quantity variance

Tk.6,400 UF 33,800 UF

Direct labor variances: Rate variance Efficiency variance

8,700 F 24,000 UF

Variable manufacturing overhead variance: Spending variance Efficiency variance

750 F 3,750 UF

Fixed manufacturing overhead variances: Budget variance Volume variance Total of variances

1,800 UF 42,000 F Tk.18,300

Notice that the total of the variances agrees with the Tk.18,300 unfavorable variance mentioned by the President. It appears that not everyone should be given a bonus for good cost control. The materials price variance, quantity variance and the labor efficiency variance are 1.8%, 6.25% and 3.6%, respectively, of the standard cost allowed and thus would warrant investigation. In addition, the variable overhead efficiency variance is 3.45% of the standard cost allowed. The reason the company‟s large unfavorable variances (for materials quantity and labor efficiency) do not show up more clearly is that they are offset for the most part by the company‟s favorable volume variance for the year. This favorable volume variance is the result of the company operating at an activity level that is well above the denominator activity level used to set predetermined overhead rates. (The company operated at an activity level of 42,000 standard DLHs; the denominator activity level set at the beginning of the year was 35,000 DLHs.) As a result of the large favorable volume variance, the 63


unfavorable price, quantity and efficiency variances have been concealed in a small “net� figure. Finally, the large favorable volume variance may have been achieved by building up inventories. P-13. FYR is an authorized dealer for a U.S. made automobile. Old cars traded in with new models are resold by the company. In addition, FYR purchases used cars that are not more than two years old models from the employees of large domestic automobile manufacturing plant located in the area, for resale to the public as used vehicles. A report showing the actual contribution margin earned in 2017 compared with the budgeted amount of FYR is summarized below:

Total 510

Actual Second Brand Hand Cars New Cars 320 190

1,324 (1,107.40)

761.60 (640.00)

216.60

121.60

Total

Number of 500 Cars - Sales Taka in million 562.40 Sales 1,320.00 (467.40) Cost of (1,080.00) goods sold 95.00 Contribution 240.00 margin

Budgeted Second Brand Hand Cars New Cars 300 200

720.00 (600.00)

600.00 (480.00)

120.00

120.00

The cost of goods sold consists of variable costs only since this is a retail business. Variable analysis is the qualitative investigation of the difference between actual and planned behavior. This analysis is used to maintain control over a business. MMH, the CEO of the company, has concerned about the declining profitability of the business and his initial reaction to the contribution margin report was: “Something has been wrong because I have been following sales closely and I knew we were selling more cars than expected when the budget was prepared. How can Tk.23.40 million from the budgeted amount possibly reduce our contribution margin? Required: As a global management accountant, calculate the following variances for the FYR for 2016 financial performance for brand new cars, second hand cars and total cars: (a) Selling price variances. (b) Sales volume variances. (c) Sales mix variances. (d) Cost of goods sold variances (variable cost variances). (e) Calculate total variances showing that the sum of variances as computed above is equal to the contribution margin variance for the year 2017. Solution:

(a) FYR For the year 2017 64


New cars 30,00,000 29,60,000

Budgeted selling price Actual selling price Sales price variances: New cars (29,60,000 – 30,00,000) X 190 Second hand cars (23,80,000 – 24,00,000) X 320 Totals cars

Second hand cars 24,00,000 23,80,000

76,00,000 64,00,000 1,40,00,000

UF UF UF

(b) FYR For the year 2017 Budgeted average contribution per second hand car 24,00,00,000 ÷ 500

4,80,000 New cars 200 190

Budgeted sales unit Actual sales unit Sales volume variances: New cars (190 – 200) X 4,80,000 Second hand cars (320 – 300) X 4,80,000 Totals cars

Second hand cars 300 320

48,00,000 96,00,000 48,00,000

UF F F

(c) FYR For the year 2017 Budgeted contribution margin per new car 12,00,00,000 ÷ 200 Budgeted contribution margin per second hand car 12,00,00,000 ÷ 300 Sales mix variances: New cars (190 – 200) X (6,00,000 - 4,80,000) Second hand cars (320 – 300) X (4,00,000 - 4,80,000) Totals cars

6,00,000 4,00,000

12,00,000 16,00,000 28,00,000

UF UF UF

(d) FYR For the year 2017 New cars 24,00,000 24,60,000

Budgeted cost of goods sold Actual cost of goods sold Cost of goods sold variances: New cars (24,60,000 – 24,00,000) X 190 Second hand cars (20,00,000 – 20,00,000) X 320 Totals cars (e)

FYR For the year 2017 65

Second hand cars 20,00,000 20,00,000 1,14,00,000 _________1,14,00,000

UF UF UF


Summary of variances: Total selling price variance Total sales volume variance Total sales mix variance Total cost of goods sold variance Total variance Unfavorable contribution margin variance

Favorable

Unfavorable 1,40,00,000

48,00,000 ________ 48,00,000

28,00,000 1,14,00,000 2,82,00,000 2,34,00,000

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CHAPTER - 3 FORECASTING AND BUDGEING TECHNIQUES

3.1. DEFINITION OF FORECASTING Forecasting is the process of making predictions of the future based on past and present data and most commonly by analysis of trends. A commonplace example might be estimation of some variable of interest at some specified future date. Prediction is a similar, but more general term. 3.2. ROLE OF FORECASTING Forecasting plays an important role in various fields of the concern. As in the case of production planning, management has to decide what to produce and with what resources. Thus forecasting is considered as the indispensable component of business, because it helps management to take correct decisions. Forecasting plays an important role in the following cases. (i) Promotion of new business: Forecasting is of utmost importance in setting up a new business. It is not an easy task to start a new business as it is full of uncertainties and risks. With the help of forecasting the promoter can find out whether he can succeed in the new business. (ii) Estimation of financial requirements: The importance of forecasting canâ€&#x;t be ignored in estimating the financial requirements of a concern. Efficient utilisation of capital is a delicate issue before the management. No business can survive without adequate capital. But adequacy of either fixed or working capital depends entirely on sound financial forecasting. (iii) Smooth and continuous working of a concern: Forecasting of earnings ensures smooth and continuous working of an enterprise, particularly to newly established ones. By forecasting, these concerns can estimate their expected profits or losses. The object of a forecast is to reduce in black and white the details of working of a concern. (iv) Success in business: The accurate forecasting of sales helps to procure necessary raw materials on the basis of which many business activities are undertaken. The accurate sales forecasting becomes the basis for several other budgets. In the absence of accurate sales forecasting, it is difficult to decide as to how much production should be done. (v) Co-Operation and co-ordination: Forecasting is not one manâ€&#x;s job. It needs proper co-ordination of all departmental heads in a company. Thus, by bringing participation of all concerned in the process of forecasting, team spirit and coordination is automatically encouraged.

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3.3. DIFFERENT METHODS OF FORECASTING (i) Moving average: Among the most popular technical indicators, moving averages are used to gauge the direction of the current trend. Every type of moving average is a mathematical result that is calculated by averaging a number of past data points. Once determined, the resulting average is then plotted onto a chart in order to allow traders to look at smoothed data rather than focusing on the day-to-day price fluctuations that are inherent in all financial markets. (ii) Time series analysis: Time series analysis comprises methods for analyzing time series data in order to extract meaningful statistics and other characteristics of the data. Time series methods take into account possible internal structure in the data. Time series data often arise when monitoring industrial processes or tracking corporate business metrics. (iii) Regression analysis: Regression analysis is a process for estimating the relationships among variables. It includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables. (iv) Exponential smoothing: Exponential smoothing is a rule of thumb technique for smoothing time series data, particularly for recursively applying as many as three low-pass filters with exponential window functions. Such techniques have broad application that is not intended to be strictly accurate or reliable for every situation. 3.4. DEFINITION OF BUDGET A budget is a quantitative expression of a financial plan for a defined period of time. It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. It expresses strategic plans of business units, organizations, activities or events in measurable terms. 3.5. PURPOSES OF BUDGET In the context of business management, the purpose of budgeting includes the following three aspects: (i) A forecast of profitability: Budgeting is a critically important part of the business planning process. Business owners and managers need to be able to predict whether a business will make a profit or not. The purpose of budgeting is basically to provide a model of how the business might perform, financially speaking, if certain strategies, events, plans are carried out. (ii) A tool for decision making: The purpose of budgeting is to provide a financial framework for the decision making process, i.e. is the proposed course action something we have planned for or not.

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(iii) A means to monitor business performance: The purpose of budgeting is to enable the actual business performance to be measured against the forecast business performance, i.e. is the business living up to the expectations. 3.6. ADVANTAGES OF BUDGET (i) As an essential part of the management process budgets compel planning, making people within an organisation think about the future. A formal budgeting procedure with specified deadlines compels operations managers to divert their attention away from dayto-day business and get down to completing the budget. (ii) Budgets promote essential principles of communication and coordination. This may be seen as applying the obvious, but the formal procedure will make the sales function talk to the operations and/or customer service function. (iii) A basis for performance evaluation is provided by budgets. They are an integral part of control and review procedure in that they establish agreed targets to be achieved, and for performance to be monitored against. This is why participation in budgets is so vital, since operations managers are effectively being asked to achieve an agreed objective within agreed parameters. (iv) Historically it has been argued that budgets can be used to identify considerable savings in overheads and costs. This may be true, but what is important is that the budgetary control system keeps the organisation fit, monitors its progress and provides an important database in the decision-making-process. 3.7. MECHANICS OF BUDGET CONSTRUCTION Constructing an effective budget involves four important steps. These are given below. Step-1: Analysis and discovery: Start by assembling your team. It takes more than one person to plan a budget. The makeup of your construction team depends on your companyâ€&#x;s size and structure. It might include the owner of your business or members of a board-appointed committee. Step-2: Design and development: Determine the potential scope of your project. Meet with your architects and design consultants to draw on their expertise as needed. Analyze your potential work, and ask consultants to come up with creative options and pitch them with drawings or models. All stakeholders and decision-makers must be aligned on the final design before you begin. Step-3: Documentation and pre-construction Itâ€&#x;s time for approval of the final design and budget you landed on at the end of phase two. Whether the final sign-off comes from your boss or the buck stops with you, ensure decision-makers understand the project and are prepared to move forward with it. Before breaking ground, have a meeting with all stakeholders (contractors, architects, utilities, etc.) to discuss the project, assess any potential issues, and work to resolve them. This will reduce risk from the start and help keep your project budget and timeline more firmly on track.

69


Step-4: Construction and closeout The project is at last underway. This will almost certainly be the longest phase of the project. Monitor the build and ensure progress is keeping as close to your projected schedules and costs as possible. Even the best-laid plans will encounter hurdles, though your hard work in the first three phases should minimize them. Keep a detailed change order log to ensure that when changes need to be made, they‟re tracked and noted for the future. Identify problem spots ahead of time and develop workarounds. 3.8. COMPONENTS OF BUDGET Sales budget: A sales budget is a plan of a business' sales outlook based on the number of units it expects to produce within a specified budget period, according to accounting tools. The sales projections are represented in units and taka. Production budget: The production budget calculates the number of units of products that must be manufactured, and is derived from a combination of the sales forecast and the planned amount of finished goods inventory to have on hand (usually as safety stock to cover for unexpected increases in demand). Direct material purchase budget: Direct materials purchase budget tell the estimated amount which will spend on buying of raw material which is used in production. Because, it is big amount, so a company should forecast it in advance by using simple accounting techniques. Direct material usage budget: This is a budget for the quantities and cost of the materials required to produce the planned production quantities. Direct labour budget: The direct labor budget is used to calculate the number of labor hours that will be needed to produce the units itemized in the production budget. A more complex direct labor budget will calculate not only the total number of hours needed, but will also break down this information by labor category. Production overhead budget: The production overhead budget contains all production costs other than the costs of direct materials and direct labor (which are itemized separately in the direct materials budget and the direct labor budget). The information in the production overhead budget becomes part of the cost of goods sold line item in the master budget. 3.9. FUNCTIONAL AND MASTER BUDGET A functional budget is a document that applies to a limited area of the company. The word “functional” does not mean that the budget works, but that it applies to a function, department, division, project or other specific aspect of the business. For example, a functional budget for the manufacture of a product line might include estimated costs of production, marketing, sales, labor, equipment and materials, as well as projected sales income. 70


A master budget is an expensive business strategy that documents expected future sales, productions levels, purchases, future expenses incurred, capital investments, and even loads to be acquired and repaid. In other words, the master budget includes all other financial budgets as wells as a budgeted income statement and balance sheet. 3.10. INCREMENTAL AND ZERO BASED BUDGETING An incremental budgeting is a budget prepared using a previous period's budget or actual performance as a basis with incremental amounts added for the new budget period. Zero-based budgeting is a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs. 3.11. IMPACT OF ZERO BASED BUDGETING ON STOCKHOLDERS The use of zero-based budgeting within 3G Capital has been profitable for stockholders. Their ability to cut costs within Kraft fast caused their stock prices to soar 36% due to the news. This type of budgeting allows for companies like Kraft and others attached to 3G Capital to take out some of the leaner competition that can undercut their prices. Zero based budgeting helps more money to flow to stockholders then into unused departments, over funded programs, and wasteful spending habits. 3.12. BUDGETARY CONTROL REPORT Budgetary control report refers to how well managers utilize budgets to monitor and control costs and operations in a given accounting period. In other words, budgetary control report is a process for managers to set financial and performance goals with budgets, compare the actual results, and adjust performance, as it is needed. 3.13. CHARACTERISTICS OF BUDGETARY CONTROL REPORT (i) Budgetary control assumes the existence of forecasts and plans of the business enterprise. (ii) Budgetary control presumes that management has made budgets for all departments/units of the enterprise and these budgets are summarised into a master budget. (iii) Budgetary control needs recording of actual performance, its continuous comparison with the budgeted performance, and the analysis of variations in terms of causes and responsibility. (iv) Budgetary control is a system suggesting suitable corrective action to prevent deviations in the future. 3.14. OBJECTIVES OF BUDGETARY CONTROL REPORT 1. To determine business policies for the attainment of desired objectives during a particular period of time. It provides definite targets of performance and gives the guidance for the execution of activities and effort. 2. To co-ordinate the activities and efforts of different departments in the enterprise so that the policies are successfully implemented. 71


3. To regulate the activities and efforts of people to ensure that the actual results conform to the planned results. 4. To operate various cost centres and departments with efficiency and economy. 5. To correct the deviations from the established standards, and to provide a basis for revision of policies. 3.15. FIXED VERSUS FLEXIBLE BUDGET Fixed budget 1. The budget designed to remain constant, regardless of the activity level reached is Fixed Budget. 2. It is static in nature.

Flexible budget 1. The budget designed to change with the change in the activity levels is Flexible Budget. 2. It is dynamic in nature.

3. Comparison between actual and budgeted levels cannot be done accurately, if there is a distinction in their activity levels. 4. It has one activity level. 5. Fixed Budget cannot be modified as per the actual volume.

3. It provides a good base for making a comparison between the actual and budgeted levels. 4. It has multiple activity level. 5. Flexible budget can be easily modified in accordance with the activity level attained.

3.16. BUDGETED INCOME STATEMENT A budgeted income statement is a financial report that compares the budgeted revenue and expense figures with the actual performance numbers achieved during the period. In other words, itâ€&#x;s a report that lists the predicted numbers side-by-side with the actual numbers to show the company performance compared with the expected performance. 3.17. USEUS OF BUDGET STATEMENTS (i) It is easy to forget where you spent that extra money last month or realize just how much you are spending on certain expenses. Budget statement allows you to see these facts in black and white. Being able to make financial decisions based on facts rather than memory will help you stay on track and set realistic goals. Making a spreadsheet and keeping receipts is a good way to manage finances, especially in a company or a household with multiple members who may not communicate about each expenditure. (ii) Budget statement allows you to set limits on your spending. A budget statement helps you determine how much money you should have going out each month based on how much income you have coming in each month. Seeing where your money goes each month can help you distinguish between fixed expenses, such as housing and food, and non-fixed expenses, such as entertainment. Cut down or eliminate non-fixed expenses, to avoid excess spending. Setting limits on your spending will help you stay accountable for your financial decisions. (iii) Without a budget statement, you have no way of really knowing where each penny is going each month. Whether you have your sights set on a new house or a car, planning

72


ahead for such expenses can help you reach your goals sooner. Set a time line in order to buy the item and determine a realistic amount to set aside each month in order to afford it. (iv) In order to build personal or business wealth, use a budget statement to save money. Many financial experts agree that the best way to build wealth and be financially responsible is to eliminate debt, invest as much as you can afford to and live within your means. Budget statement can help you make your money work for you and put you on the road to financial freedom. 3.18. DEFINITION OF CASH BUDGET A cash budget is a budget that relates to objectives to be achieved and is to plan for future inflows and outflows of cash. The period of cash budget is usually short. It is prepared in advance and is based on future plan of action. 3.19. METHODS OF PREPARING CASH BUDGET There are two methods of preparing cash budget: (a) Receipts and payments method: It is normally prepared by month for the budget year in advance. It starts with forecast cash balance at the commencement of the budget period and by adding budgeted receipts for each month and subtracting the budgeted payments, the expected cash balance at the end of each month is ascertained. (b) Funds flow method: The funds flow method of cash budgeting is to substitute cash from operations. Cash from operation is determined by taking net profit as the basis and making adjustment for - depreciation - non-operation incomes and expenses - increase or decrease in current account items (except cash)

73


USEFUL FORMULAS 1. By the method of least squares, the equation of trend line is, Y = a + bx Here, a= b=

 Y - b X N  XY - a  X

X

2

If ∑X is equal to zero, then a= b=

Y N

 XY X

2

2. The formula for regression line is, Y = a + bx Here, a=

 Y - b X

b=

N  XY -  X Y

N

N (X 2 )   (X )2

3. The coefficient of determination =

Explained sum of squares Total sum of squares

Here, Explained sum of squares = b (N ∑XY - ∑X ∑Y) Total sum of squares = N ∑Y2 – (∑Y)2

74


PROBLEMS AND SOLUTIONS P-1. The standard cost sheet of Nobbodoy Company for the year 2016 is given below: Particulars

Standard cost per unit

Sales Variable costs: Direct materials Direct labour Manufacturing costs Selling and administrative expenses Total variable costs Fixed cost: Manufacturing costs Selling and administrative expenses Total fixed costs

Tk.100 Tk.20 Tk.10 Tk.6 Tk.4 Tk.40 Tk.100,000 Tk.50,000 Tk.150,000

For the year 2017, the firm had following expected changes from the standard cost sheet. (a) The sales price would be increased by 10%. (b) The material price would be increased by 8%. (c) The labour cost would be increased by 6%. (d) The fixed manufacturing costs would be increased by Tk.40,000 for insurance, property taxes and salaries. (e) The fixed selling and administrative expenses would be increased by Tk.6,000. The firm wishes to spend Tk.4,000 more for advertising during 2017. Required: Prepare the master budget for 10,000 units during 2017. Solution:

Particulars Sales Less. Variable costs: Direct materials Direct labour Manufacturing overheads Selling & admin. expenses Total variable costs Contribution margin Less. Fixed costs: Manufacturing costs Selling & admin. expenses Total fixed costs Operating income 75

Nobbodoy Company Master Budget For the year 2017 Cost per unit Tk. 110 21.6 10.6 6 4 42.2 67.8

Total budgeted costs Tk. 11,00,000 216,000 106,000 60,000 40,000 422,000 678,000 140,000 60,000 200,000 478,000


P-2. Mosaj & Associates has provided the following information regarding Juneâ€&#x;s results.

Revenue Conversion costs Salaries Utilities Rent Miscellaneous

Revenue and Cost Formula Tk.13.00/unit Tk.3.25/unit Tk.8,000 Tk.600 + Tk.0.50/unit Tk.5,000 Tk.800 + Tk.0.80/unit

Actual Results Tk.28,000 7,000 7,600 1,550 5,000 2,500

Required: (a) Prepare the companyâ€&#x;s planning budget assuming that 2,000 units were manufactured. (b) Assume that 2,100 units were actually manufactured. Prepare the flexible budget for this level of activity. (c) Prepare a flexible budget performance report for the company. Solution: (a) Mosaj & Associates Planning Budget for 2,000 units

Revenue Expenses: Conversion costs Salaries Utilities Rent Miscellaneous Total expenses Net operating income

Revenue and cost formula Tk.13.00/unit

Taka 26,000

Tk.3.25/unit Tk.8,000 Tk.600 + Tk.0.50/unit Tk.5,000 Tk.800 + Tk.0.80/unit

6,500 8,000 1,600 5,000 2,400 23,500 2,500

(b) Mosaj & Associates Flexible Budget for 2,100 units

Revenue Expenses: Conversion costs Salaries Utilities Rent Miscellaneous Total expenses Net operating income

Revenue and cost formula Tk.13.00/unit

Taka 27,300

Tk.3.25/unit Tk.8,000 Tk.600 + Tk.0.50/unit Tk.5,000 Tk.800 + Tk.0.80/unit

6,825 8,000 1,650 5,000 2,480 23,955 3,345

76


(c) Mosaj & Associates Flexible budget performance report Revenue and Planning cost formula Budget (1)

Activity variance (2) – (1)

Flexible Budget (2)

2,000 Tk. 26,000

Tk. 1,300 F

6,500 8,000 1,600

Number of units Revenue Expenses: Material costs Salaries Utilities Rent Miscellaneous

Tk. 13.00/unit 3.25/unit 8,000 600 + 0.50/unit 5,000 800 + Tk.0.80/unit

Total expenses Net operating income

Revenue and spending variances (3) – (2)

Actual results (3)

2,100 Tk. 27,300

Tk. 700 F

Tk. 28,000

325 U 0 50 U

6,825 8,000 1,650

175 U 400 F 100 F

7,000 7,600 1,550

5,000 2,400

0 80 U

5,000 2,480

0 20 U

5,000 2,500

23,500 2,500

455 U 845 F

23,955 3,345

305 F 1,005 F

23,650 4,350

P-3. XYZ enterprise produces duck decoys for hunters. Each unit requires 0.50 direct labor hour. The relevant range of activity is between 6,000 and 9,000 direct labor hours. The following estimates were derived for the company after analyzing its cost records: Direct materials Direct labor Supervisor‟s salary Other indirect labor Utilities Maintenance Property tax insurance Depreciation Indirect materials

Tk.3.00 per unit of product Tk.6.50 per hour Tk.15,000 per month Tk.5.00 per hour Tk.3,700 plus Tk.0.25 per hour Tk.5,000 plus Tk.0.60 per hour Tk.4,850 per month Tk.0.35 per unit on a unit of production basis Tk.0.20 per unit of production

Required: (a) Prepare a flexible budget for XYZ for each thousand direct labor hours of activity within the relevant range. (b) Assuming that the company operates for 8,500 hours and actual fixed overheads incurred is Tk.31,300 and variable overhead is Tk.125,000, calculate the overhead variances for spending, efficiency and volume. Solution:

77


(a) XYZ Enterprise Flexible Budget Level of activity (Hours) Level of activity (Units) Direct material cost (Tk.) Direct labor cost (Tk.) Prime cost (Tk.) Variable overhead costs (Tk.): Indirect materials Indirect labor Utilities Maintenance Depreciation Total variable overhead (Tk.) Fixed overhead costs (Tk.): Supervisorâ€&#x;s salary Property tax insurance Utilities Maintenance Total fixed overhead (Tk.) Total costs (Tk.)

6,000 12,000 36,000 39,000 75,000

7,000 14,000 42,000 45,500 87,500

8,000 16,000 48,000 52,000 100,000

9,000 18,000 54,000 58,500 112,500

2,400 30,000 1,500 3,600 4,200 41,700

2,800 35,000 1,750 4,200 4,900 48,650

3,200 40,000 2,000 4,800 5,600 55,600

3,600 45,000 2,250 5,400 6,300 62,550

15,000 4,850 3,700 5,000 28,550 145,250

15,000 4,850 3,700 5,000 28,550 164,700

15,000 4,850 3,700 5,000 28,550 184,150

15,000 4,850 3,700 5,000 28,550 203,600

(b) Calculation of overhead variances for spending, efficiency and volume. Spending variance: Actual overhead Fixed Variable

Tk.31,300 125,000 156,300 28,550 127,750

Budgeted overhead Actual variable overhead Variable overhead applied (8,500 Hours X

Tk.41,700 ) 6,000 Hours

Spending variance

59,075 68,675

Efficiency variance: Budgeted allowance based on capacity utilized: Fixed overhead Tk.28,550 Tk.41,700 Variable overhead applied (8,500 Hours X ) 59,075 6,000 Hours Applied overhead (8,500 X 11.71*) Efficiency variance *Total overhead rate

Tk.87,625 99,535 11,910

78


Volume variance: Actual fixed overhead Applied fixed overhead Tk.28,550 (8,500 Hours X ) 6,000 Hours Volume variance

Tk.31,300 40,460

9,160

P-4. The following particulars are available from the records of Safar Company for two years. Year-1 Year-2 Production quantity 5000 units 7000 units Costs: Tk. Tk. Direct materials 50,000 70,000 Direct labour 40,000 56,000 Overheads: Indirect materials 2,500 3,500 Indirect labour 2,000 2,800 Repairs and maintenance 1,100 1,500 Inspection 700 900 Insurance 2,000 2,000 Depreciation 3,000 3,000 Total overheads 11,300 13,700 Total factory costs 1,01,300 1,39,700 Total production quantity at 100% capacity is 10,000 units. Required: Prepare a flexible budget for 60% and 80% capacity. Solution:

Particulars Production quantity Costs: Direct materials Direct labour Overheads: Variable overheads: Indirect materials Indirect labour Repairs and maintenance Inspection Total variable overheads Fixed overheads: Repairs and maintenance Inspection Insurance Depreciation 79

Safar Company Flexible Budget Cost per unit Tk. 10 8

60% Capacity 6,000 units Tk. 60,000 48,000

80% Capacity 8,000 units Tk. 80,000 64,000

0.5 0.4 0.2 0.1 1.2

3,000 2,400 1,200 600 7,200

4,000 3,200 1,600 800 9,600

100 200 2,000 3,000

100 200 2,000 3,000


Total fixed overheads Total overheads Total factory costs

5,300 12,500 1,20,500

5,300 14,900 1,58,900

P-5. Padma Corporation uses a flexible budgeting system. The following flexible budget is provided for 80% and 100% of normal capacity. Particulars 80% 100% Capacity Capacity Units of production 2,000 2,500 Tk. Tk. Direct labor cost 40,000 50,000 Direct materials 60,000 75,000 100,000 125,000 Factory overhead: Utilities 9,000 10,000 Supplies 8,000 10,000 Indirect labor 10,000 12,500 Depreciation on plant 30,000 30,000 Miscellaneous expense 10,000 12,000 Total factory overhead 67,000 74,500 Required: (a) Prepare a flexible budget for 2,600 units. (b) If 100% capacity is used for predetermined rate, what would be the under/over applied factory overhead for 2,600 units production? Solution: (a) Padma Corporation Flexible Budget For 2,600 units Particulars Units of production Direct labor cost Direct materials Prime cost Variable factory overheads: Utilities Supplies Indirect labor Miscellaneous expense Total variable factory overheads Fixed factory overheads: Utilities Depreciation on plant Miscellaneous expense Total fixed factory overhead Total factory overheads Total costs

Unit cost Tk. 20 30 50

Total cost 2,600 Tk. 52,000 78,000 130,000

2 4 5 4 15

5,200 10,400 13,000 10,400 39,000 5,000 30,000 2,000 37,000 76,000 206,000 80


Tk.74,500 2,500 = Tk.29.80

(b) At 100% capacity, predetermined overhead rate =

If production is 2,600 units over applied overhead will be = 2,600 – 2,500 units = 100 units Predetermined factory overhead = 100 X Tk.29.80 = Tk.2,980 P-6. Prepare a budget for 2017 for the variable direct labour costs and overhead expenses of a production department flexed at the activity levels of 80%, 90% and 100%, using the information listed below. (a) The variable direct labour hourly rate is expected to be BDT 7.50 (b) 100% activity represents 60,000 direct labour hours (c) Variable costs: Indirect labour BDT 0.75 per direct labour hour Consumable supplies BDT 0.375 per direct labour hour Canteen and other welfare services 6% of direct and indirect labour costs (d) Semi‐variable costs are expected to relate to the direct labour hours in the same manner as for the last five years: Year Direct Labour (hours) Semi‐variable cost 2012 64,000 20,800 2013 59,000 19,800 2014 53,000 18,600 2015 49,000 17,800 2016 40,000 (estimate) 16,000 (estimate) (e) Fixed Cost: Depreciation 18,000 Maintenance 10,000 Insurance 4,000 Rates 15,000 Management Salaries 25,000 (f) Inflation is to be ignored. Required: Calculate the budgeted cost allowance (i.e; expected expenditure) for 2017 assuming that 57,000 direct labour hours are worked. Solution: Flexible budget

Variable direct labour Other variable costs: Indirect labour Consumable supplies 81

80% level 48,000 hrs BDT‟000 360.00

90% level 54,000 hrs BDT‟000 405.00

100% level 60,000 hrs BDT‟000 450.00

36.00 18.00

40.50 20.25

45.00 22.50


Canteen & other welfare services Total variable costs Semi-variable costs (w1) Total semi-variable costs Fixed costs: Depreciation Maintenance Insurance Rates Management salaries Total fixed costs Budgeted costs

23.76 437.76 17.60 17.60

26.73 429.48 18.80 18.80

29.70 547.20 20.00 20.00

18.00 10.00 4.00 15.00 25.00 72.00 527.36

18.00 10.00 4.00 15.00 25.00 72.00 583.28

18.00 10.00 4.00 15.00 25.00 72.00 639.20

The budgeted cost allowance for 57,000 direct labour hours: Variable costs 57,000 hrs X {7.50 + 0.75 + 0.375 + (7.50 + 0.75) X 6%} Semi-variable costs BDT 8,000 + (57,000 hrs X BDT 0.20) Fixed costs

BDT 519,840 19,400 72,000 611,240

Working: 1. Determination of semi-variable costs using high-low method: Total cost of 64,000 hours Total cost of 40,000 hours Variable cost of 24,000 hours

BDT 20,800 BDT 16,000 BDT 4,800

BDT 4,800 24,000 = BDT 0.20

Variable cost per hour =

Fixed costs = BDT 20,800 – (64,000 hrs X BDT 0.20) = BDT 20,800 – BDT 12,800 = BDT 8,000 Semi-variable costs: For 80% level = (48,000 hrs X BDT 0.20) + BDT 8,000 = BDT 17,600 For 90% level = (54,000 hrs X BDT 0.20) + BDT 8,000 = BDT 18,800 For 100% level = 608,000 hrs X BDT 0.20) + BDT 8,000 = BDT 20,000 P-7. RS has recently introduced an activity based costing system. RS manufactures two products, details of which are given below:

82


Budgeted production per annum (Units) Batch size (Units) Machine set-ups per batch Processing time per unit (Minutes)

Product R 80,000 100 3 3

Product S 60,000 50 3 5

The budgeted annual costs for two activities are as follows: Machine set-up Tk.180,000 Processing Tk.108,000 Determine: (a) The budgeted processing cost per unit of Product R. (b) The budgeted machine set-up cost per unit of product S. Solution: (a) Budgeted production per annum (Units) Number of batches 80,000 รท 100 = 800 60,000 รท 50 = 1,200 Number of machine set-ups 800 X 3 = 2,400 1,200 X 3 = 3,600 Total processing time (Minutes) 80,000 X 3 = 240,000 60,000 X 5 = 300,000

Tk.108,000 540,000 = Tk.0.20

Cost driver rate =

Total processing costs = 240,000X Tk.0.20 = Tk.48,000

Tk.48,000 80,000 = Tk.0.60

Processing cost per unit =

(b)

Tk.108,000 6,000 = Tk.30 per set-up

Cost driver rate =

Total set-up costs = 3,600X Tk.30 = Tk.108,000

83

Product R 80,000 800

Product S 60,000 1,200

Total 140,000 2,000

2,400

3,600

6,000

240,000

300,000

540,000


Tk.108,000 60,000 = Tk.1.80

Set-up cost per unit =

P-8. ABC Company wants to prepare budgets for one of its products Suffix. Standard cost data for the product for next year are as follows: Per unit Sales Tk.50 Direct materials: X at Tk.3 per kg 20 kgs Y at Tk.4 per kg 15 kgs Direct labour: Semi-skilled at Tk.5 per hour 8 hours Skilled at Tk.6 per hour 6 hours Budgeted inventories for the next year are as follows: Beginning Ending

500 units 600 units

Beginning Ending

Material X 20,000 kgs 25,000 kgs

Material Y 15,000 kgs 20,000 kgs

Budgeted sales for the next year are 10,000 units. Required: On the basis of the preceding data, prepare the following budgets for next year: (a) Sales budget, in taka; (b) Production budget, in units; (c) Direct material usage budget, in kgs; (d) Direct material purchase budget, in kgs and taka; (e) Direct labour budget, in hours and taka. Solution: (a) ABC Company Sales budget For the next year Budget sales unit Budgeted selling price per unit Budgeted sales

10,000 Tk.50 Tk.500,000

(b) ABC Company Production budget For the next year

84


Budgeted sales Add. Desired ending inventory Total units needed Less. Beginning inventory Budgeted production

10,000 units 600 units 10,600 units (500 units) 10,100 units

(c) ABC Company Direct material usage budget For the next year Material X 10,100 units 20 kgs 202,000kgs

Budgeted production Direct material required per unit Total direct material usage

Material Y 10,100 units 15 kgs 151,500kgs

(d) ABC Company Direct material purchase budget For the next year Material X 202,000 kgs 25,000 kgs 227,000 kgs 20,000 kgs 207,000 kgs Tk.3 Tk.621,000

Materials required for production Add. Ending inventory Total material needed Less. Beginning inventory Direct material purchases Standard price per kg Direct material purchases

Material Y 151,500 kgs 20,000 kgs 171,500kgs 15,000 kgs 156,500 kgs Tk.4 Tk.626,000

(e) ABC Company Direct labour budget For the next year

Required for production (10,100 X 8, 6) Standard rate per hour Total direct labour needed

Semi-skilled 80,800 hrs Tk.5 Tk.404,000

Skilled 60,600 hrs Tk.6 Tk.363,600

P-9. XYZ Company produces three products A, B & C. For the coming accounting period budgets are to be prepared based on the following information: Budgeted sales Product – A Product – B Product – C

85

2000 at Taka 100 each 4000 at Taka 130 each 3000 at Taka 150 each


Budgeted usage of raw materials Product – A Product – B Product – C Cost per unit of materials

RM 11 Unit 5 3 2 Taka 5

RM 22 Unit 2 2 1 Taka 3

RM 33 Unit 2 3 Taka 4

Product A 500 600

Product B 800 `1000

Product C 700 800

RM 11 Unit 21,000 18,000

RM 22 Unit 10,000 9,000

RM 33 Unit 16,000 12,000

Product B 6 Taka 9

Product C 8 Taka 9

Finished inventory budget Opening Closing Raw materials inventory budget

Opening Closing

Expected hours per unit Expected hourly rate (labour)

Product A 4 Taka 9

Solution: Operating budget of XYZ Company Sales budget:

Sales quantity (Units) Sales price (Tk.) Sales revenue (Tk.)

Product A 2,000 100 200,000

Product B 4,000 130 520,000

Product C 3,000 150 450,000

Total 9,000 1,170,000

Production budget: Product A 2,000 600 2,600 (500) 2,100

Sales quantity Add. Closing inventories Less. Opening inventories Budgeted production

Product B 4,000 1,000 5,000 (800) 4,200

Product C 3,000 800 3,800 (700) 3,100

Material usage budget:

Product A Product B Product C Budgeted material usage

Production Units 2,100 4,200 3,100

RM 11 Units 10,500 12,600 6,200 29,300

RM 22 Units 4,200 8,400 3,100 15,700

RM 33 Units 0 8,400 9,300 17,700 86


Material purchase budget: RM 11 29,300 18,000 47,300 (21,000) 26,300 Tk.5 Tk.131,500

Budgeted material usage Closing inventories Less. Opening inventories Budgeted production Cost per unit of material Budgeted material purchases

RM 22 15,700 9,000 24,700 (10,00) 14,700 Tk.3 Tk.44,100

RM 33 17,700 12,000 29,700 (16,000) 13,700 Tk.4 Tk.54,800

Labour budget: Product

Production Units

A B C

2,100 4,200 3,100

Hours required per unit 4 6 8

Labour Rate per budget total hour hours 8,400 9 25,200 9 24,800 9 Budgeted total wages

Cost Tk. 75,600 226,800 223,200 525,600

P-10. Araba is a restaurant that operates five days in a week. It has four staff, each paid a wage of Tk.100 per hour on the basis of hours actually worked. It also has a Manager and an Accountant, each of whom is paid Tk.10,000 per month. Arabaâ€&#x;s budget and actual figures for the month of April was as follows:

Number of meals Revenue: Food Soft drinks Total revenue Variable costs: Staff wages Food costs Soft drink costs Energy costs Total variable costs Fixed costs: Manager & Accountant salary Rent Total fixed costs Total costs Operating income

Budget 1,000 Tk.

Actual 1,100 Tk.

60,000 20,000 80,000

80,000 15,000 95,000

20,000 13,000 5,000 2,000 40,000

23,000 18,000 6,000 3,000 50,000

20,000 5,000 25,000 65,000 15,000

20,000 5,000 25,000 75,000 20,000

The budget above is based on the following assumptions: (a) The restaurant is only open five days a week and there are four weeks in a month. The average number of orders each day is 45 and demand is evenly spread across all the days in the month. 87


(b) The restaurant offers two types of meals. Meal 1, which costs Tk.50 per meal and Meal 2, which costs Tk.60 per meal. In addition to this, irrespective of which meal the customer orders, the average customer consumes two drinks each at Tk.10 per drink. Therefore, the average spend per customer is either Tk.100 or Tk.120 including soft drinks, depending on the type of meal selected. The April budget is based on 50% of customers ordering Meal 1 and 50% of customers ordering Meal 2. (c) Food costs represent 15% of revenue from food sales. (d) Soft drink costs represent 20% of revenue from soft drink sales. (e) When the number of orders per day does not exceed 50, each member of hourly paid staff is required to work exactly four hours per day. For every incremental increase of five in the average number of orders per day, each member of staff has to work 0.5 hours of overtime for which they are paid at the increased rate of Tk.150 per hour. You should assume that all costs for hourly paid staff are treated wholly as variable costs. (f) Energy costs are deemed to be related to the total number of hours worked by each of the hourly paid staff and are absorbed at the rate of Tk.10 per hour worked by each of the four staff. Required: Prepare a flexed budget for the month of April, assuming that the standard mix of customers remains the same as budgeted. Solution: Araba Flexed budget Number of meals

1,100 Tk.

Revenue: Sales of food (w-1) Sales of soft drinks (w-1) Total revenue Variable costs: Staff wages (w-2) Food costs (w-3) Soft drink costs (w-4) Energy costs (w-5) Total variable costs Fixed costs: Manager & Accountant salary Rent Total fixed costs Total costs Operating income

Tk.

60,500 22,000 82,500 32,000 9,075 4,400 4,000 49,475 20,000 5,000 25,000 74,475 8,025

Workings: 1. Revenue: Food = 1,100 X (

Tk.50  Tk.60 ) 2

= Tk.60,500 88


Soft drink = 1,100 X (Tk.10 X 2) = Tk.22,000 2. Staff wages:

1,100 (5 days X 4 weeks) = 55 orders per day

Average number of orders per day = Therefore extra orders = 55 – 45 = 10 per day

10 = 2, therefore, 1 hour (2 X 0.5 hours) of overtime must be paid. 5

4 staff X 1 hour X 5 days X 4 weeks = 80 extra hours Extra wages = 80 extra hours X Tk.150 = Tk.12,000 Total flexed wages = Tk.20,000 + Tk.12,000 = Tk.32,000 3. Food costs = Tk.60,500 X 15% = Tk.9,075 4. Soft drink costs = Tk.22,000 X 20% = Tk.4,400 5. Energy costs: Standard total hours worked = (4 staff X 4 hours) X 5 days X 4 weeks = 320 hours Extra hours worked = 80 (From working 2) Total hours = 320 hours + 80 hours = 400 hours Total energy costs = 400 hours X Tk.10 = Tk.4,000 P-11. Dhaka‟s major towns and cities are maintained by local government organisations (LGO), which are funded by central government. The LGO submit a budget each year which forms the basis of the funds received. You are provided with the following information as part of the 2017 budget preparation. Overheads Overhead costs are budgeted on an incremental basis, taking the previous year‟s actual expenditure and adding a set % to allow for inflation. The details for these are as follows:

89


Overhead cost category Property cost Central wages Stationery

2015 cost Tk. 200,000 300,000 50,000

Inflation adjustment between 2016 & 2017 + 6% + 4% 0%

Road repairs In 2016, it is expected that 3,000 meters of road will need repairing but a contingency of an extra 10% has been agreed. In 2015, the average cost of a road repair was Tk.20,000 per meter repaired, but this excluded any cost effects of extreme weather conditions. The following probability estimates have been made in respect of 2017: Weather type predicted Good Poor Bad

Probability 0.5 0.1 0.2

Increase in repair cost 0% + 10% + 20%

Inflation on road repairing costs is expected to be 6% between 2016 and 2017. New roads New roads are budgeted on a zero base basis and will have to complete for funds along with other capital projects such as hospitals and schools. Required: (a) Prepare the overheads budget for 2017. (b) Prepare the budgets for road repairs for 2017. (c) Explain the problems associated with using expected values in budgeting by an LGO and explain why a contingency for road repairs might be needed. Solution: (a) Overhead budget for 2017 Property cost = Tk.200,000 + (Tk.200,000 X 6%) = Tk.200,000 + Tk.12,000 = Tk.212,000 Central wages = Tk.300,000 + (Tk.300,000 X 4%) = Tk.300,000 + Tk.12,000 = Tk.312,000 Stationery = Tk.50,000 (b) Budget for road repairs for 2017: Expected amount of road repairs = 3,000 meters + 10% of contingency = 3,000 meters + (3,000 meters X 10%) = 3,000 meters + 300 meters = 3,300 meters 90


Expected value of weather related repair cost increase = (0.5 X 0%) + (0.1 X 10%) + (0.2 X 20%) = 0 + 0.01 + 0.04 = 0.05 or 5% After inflation road repair cost = Tk.20,000 + 6% per meter = Tk.20,000 + (Tk.20,000 X 6%) = Tk.20,000 + Tk.1,200 = Tk.21,200 Budget for road repairs = {Tk.21,200 + (Tk.21,200 X 5%)} X 3,300 meters = (Tk.21,200 + Tk.1,060) X 3,300 meters = Tk.22,260 X 3,300 meters = Tk.73,458,000 (c) Problems with using expected values in budgeting: - The probability of different types of weather conditions has been estimated which is potentially unreliable. - It is also difficult to accurately predict the effect of weather conditions on road. - There is a high degree of uncertainty associated with the road repair budget. P-12. A company produces three types of products that are sold to retailers. Extracts from the budget for the last year are given below:

Sales (Unit) Selling price per unit (Tk.) Direct material cost per unit (Tk.) Direct labour cost per unit (Tk.)

Product A 90,000 1.40 0.50 0.25

Product B 180,000 1.80 0.80 0.25

Product C 130,000 2.25 1.10 0.25

Overhead costs for the budget were estimated using the high-low method based on the total overhead costs for three previous years. Output (Units) Total overheads (Tk.)

360,000 508,000

340,000 496,000

420,000 548,000

Actual results for the last year were as follows:

Sales (Unit) Selling price per unit (Tk.) Direct material cost per unit (Tk.) Direct labour cost per unit (Tk.) Variable overhead per unit (Tk.) Actual fixed overheads: Tk.273,000

91

Product A 93,000 1.41 0.55 0.26 0.32

Product B 198,000 1.81 0.75 0.27 0.33

Product C 139,000 2.26 1.05 0.24 0.32


The company operates a just-in-time system for purchasing and production and does not hold any inventory. You should ignore inflation. Required: (a) Calculate for the original budget, the budgeted fixed overhead costs, the budgeted variable overhead cost per unit and the budgeted total overhead costs. (b) Prepare for the last year, a budget control statement on a marginal cost basis for the product B. The statement should show the original budget, the flexed budget and the total budget variances for sales revenue and each cost element. (c) By using the figures calculated in (ii), discuss the benefits of flexible budgeting for planning and control process. Solution: (a) Using the high-low method, we have, 420,000 units 340,000 units 80,000 units

Tk.548,000 Tk.496,000 Tk.52,000

High Low

Budgeted variable overhead cost per unit Tk.52,000 = 80,000 units = Tk.0.65 per unit Budgeted fixed overhead costs = Tk.548,000 – (Tk.420,000 X Tk.0.65) = Tk.548,000 – Tk.273,000 = Tk.275,000 Original budgeted number of units = 90,000 + 180,000 + 130,000 = 400,000 units Budgeted total overhead costs = Tk.275,000 + (400,000 units X Tk.0.65) = Tk.275,000 + Tk.260,000 = Tk.535,000 (b) Budget control statement Marginal cost basis For the product B

Sales revenue Variable costs:

Original budget Tk. 324,000

Flexed Budget (w1) Tk. 356,400

Actual (w2) Tk. 358,380

Variance Tk. 1,980 F

92


Direct mater cost Direct labour cost Variable overhead cost Total variable costs Contribution

144,000 45,000 117,000 306,000 18,000

158,400 49,500 128,700 336,600 19,800

148,500 53,460 65,340 267,300 91,080

9,900 F 3,960 A 63,360 F 69,300 F 71,280 F

Workings: 1. Flexed budget Sales revenue = 198,000 units X Tk.1.80 = Tk.356,400 Direct material cost = 198,000 units X Tk.0.80 = Tk.158,400 Direct labour cost = 198,000 units X Tk.0.25 = Tk.49,500 Variable overhead cost = 198,000 units X Tk.0.65 = Tk.128,700 2. Actual Sales revenue = 198,000 units X Tk.1.81 = Tk.358,380 Direct material cost = 198,000 units X Tk.0.75 = Tk.148,500 Direct labour cost = 198,000 units X Tk.0.27 = Tk.53,460 Variable overhead cost = 198,000 units X Tk.0.33 = Tk.65,340 (c) Benefits of flexible budgeting: Flexible budget removes the effect of volume differences. By flexing the budget above, we have removed the effect on sales revenue of the differences between budgeted sales volume and actual sales volume. But there is still a variance of Tk.1,980 (F) This means that, the actual selling price must have been higher than the budgeted selling price. If the flexed budget above had been compared to the actual results there would have been an adverse material variance of Tk.148,500 – Tk.144,000 = Tk.4,500. However taking into account the difference in volume using flexed budget gives a favourable variance of Tk.9,900. P-13. ABC Co. wishes to arrange overdraft facilities with its Bankers during the period April to June, 2018, when it will be manufacturing mostly for stock. Prepare a cash budget for the above period from the following data, indicating the extent of the bank facilities the company will require at the end of each month: (a) Sales Purchases Wages TK TK TK February 2018 180,000 124,800 12,000 March 2018 192,000 144,000 14,000 April 2018 108,000 243,000 11,000 May 2018 174,000 246,000 10,000 June 2018 126,000 268,000 15,000 (b) 50% of credit sales are realized in the month of following the sales and the remaining 50% in the second month following. Creditors are paid in the month following the month of purchase. (c) Cash at bank on April 1, 2018 estimated Tk. 25,000. Solution: ABC Company Cash budget 93


Opening cash balance Cash receipts: Collection from February sales March April May Total cash receipts Total cash available Cash disbursements: Payment to suppliers Wages Total cash disbursements Closing cash balance

April 2018 Tk. 25,000

May 2018 Tk. 53,000

June 2018 Tk. (51,000)

90,000 96,000 _____186,000 211,000

96,000 54,000 _____150,000 203,000

54,000 87,000 141,000 90,000

144,000 14,000 158,000 53,000

243,000 11,000 254,000 (51,000)

246,000 10,000 256,000 (166,000)

1 %. 2 Month Budgeted sales Labour cost Expenses incurred (Tk.) (Tk.) (Tk.) January 40,000 3,000 4,000 February 60,000 3,000 6,000 March 160,000 5,000 7,000 April 120,000 4,000 7,000 (b) It is a management policy to have sufficient inventory in hand at the end of each month to meet half of the next monthâ€&#x;s sales demand. (c) Suppliers for materials and expenses are paid in the month after the purchases are made/ expenses incurred. Labour is paid in full by the end of each month. (d) Expenses include a monthly depreciation charge of Tk.2,000. (e) 75% of sales are for cash and 25% of sales are on one monthâ€&#x;s credit. (f) The company will buy equipment costing Tk.18,000 for cash in February and will pay a dividend of Tk.20,00 in March. The opening cash balance at 1 February is Tk.1,000.

P-14. (a) Saad Limited operates a retail business. Purchases are sold at cost plus 33

Required: Prepare a cash budget for the months of February and March. Solution: Saad Limited Cash Budget

Opening cash balance Cash receipts: Collection from sales (w1) Total cash receipts Total cash available Cash disbursements: Payment to suppliers (w2) Labour

February 1,000

March (4,500)

55,000 55,000 56,000

135,000 135,000 130,500

37,500 3,000

82,500 5,000 94


Expenses Purchase of equipment Dividend Total cash disbursements Closing cash balance

2,000 18,000 _____60,500 (4,500)

4,000 20,000 111,500 19,000

Workings: 1. Collection from sales: From January sales February sales March sales

February 10,000 45,000 ____ 55,000

March 15,000 120,000 135,000

2. Payment to suppliers: 1 1 ) + (Tk.45,000 X ) 2 2 = Tk.15,000 + Tk.22,500 = Tk.37,500 1 1 March = (Tk.45,000 X ) + (Tk.120,000 X ) 2 2 = Tk.22,500 + Tk.60,000 = Tk.82,500

February = (Tk.30,000 X

P-15. SKYLARK Ltd. manufactures and sells interior furnishings. They have recently completed financial projections for the year ahead and they now require a cash budget to present to their Bank manager. They have provided you with the following information to assist with calculations: Sales Sales are projected at 66,000 units for the year with expected revenue of Tk.660,000 for the year. Sales and corresponding production is spread evenly throughout the year, with no movement in stocks anticipated. There are opening debtors of one monthâ€&#x;s credit sales. Customers 50% of sales are paid in cash and avail of a 2% discount offer. The remaining customers take one monthâ€&#x;s credit, although 5% of these will result in bad debts. Products Products are produced in batches of 500 and each batch requires 400 kg of raw materials and 150 hours of labour. Direct materials Materials costs are estimated to be Tk.2 per kg and the main supplier allows two months credit. Direct labour Direct labour is projected at a cost of Tk.12.00 per hour inclusive of all employer costs. 60% of labour costs are paid in the month incurred and the remainder, representing employer costs, is paid in the following month. At the start of the year Tk.8,000 is owed in respect of employer costs. Production overheads Production overheads are estimated at Tk.4,000 per month for the first six months, increasing to Tk.5,000 in the second half of the year. 95


Creditors Sales and marketing costs Purchase of new machine Bank balance

Creditors at the start of the year are Tk.20,000 and these are paid in the first quarter. Sales and marketing costs are estimated at 5% of turnover and are paid in the month of sale. The company intends to purchase a new machine costing Tk.130,000, which will be paid for in Quarter three. At the start of the year the company Bank balance is overdrawn by Tk.104,000.

Required: Prepare a statement setting out quarterly cash budgets for the year. Solution: SKYLARK Limited Cash Budget Quarter 1 Quarter 2 Quarter 3 Cash inflows: Cash sales (W-1) Credit sales (W-2) Cash outflows: Paid to creditors(W-3) Labour – net (W-4) Labour – employer costs (W-4) Production overheads Sales and marketing costs (W-5) Purchase of equipment Net inflows/(outflows) Opening balance Closing balance

Quarter 4

Total

80,850 78,375 159,225

80,850 78,375 159,225

80,850 78,375 159,225

80,850 78,375 159,225

323,400 313,500 636,900

28,800 35,640 23,840

26,400 35,640 23,760

26,400 35,640 23,760

26,400 35,640 23,760

108,000 142,560 95,120

12,000 8,250

12,000 8,250

15,000 8,250

15,000 8,250

54,000 33,000

0 108,530 50,695 (104,000) (53,305)

0 106,050 53,175 (53,305) (130)

130,000 239,050 (79,825) (130) (79,955)

0 130,000 109,050 562,680 50,175 74,220 (79,955) (104,000) (29,780) (29,780)

Workings: 1. Cash sales:

50% are cash sales 2% discount offered Net cash sales

Quarter 1 82,500 1,650 80,850

Quarter 2 Quarter 3 82,500 82,500 1,650 1,650 80,850 80,850

Quarter 4 82,500 1,650 80,850

Total 330,000 6,600 323,400

Quarter 1 82,500 4,125 78,375

Quarter 2 Quarter 3 82,500 82,500 4,125 4,125 78,375 78,375

Quarter 4 82,500 4,125 78,375

Total 330,000 16,500 313,500

2. Credit sales:

50% are credit sales 5% are bad debts Net credit sales

96


3. Paid to creditors: 66,000 units X 400 kg X Tk.2 500 = 132 batches X 400 kg X Tk.2 = 52,800 kg X Tk.2 = Tk.105,600 per year or, Tk.26,400 per quarter or, Tk.8,800 per month

Purchases =

Quarter 1 20,000 8,800 _____ 28,800

Opening creditor Month 1 3 months purchases Total paid to creditors

Quarter 2

Quarter 3

Quarter 4

26,400 26,400

26,400 26,400

26,400 26,400

4. Labour: 66,000 units X 150 hours X Tk.12 500 = 132 batches X 150 hours = 19,800 hours X Tk.12 = Tk.237,600 per year or, Tk.59,400 per quarter or, Tk.19,800 per month

Labour – net = Tk.19,800 per month X 60% = Tk.11,880 per month or Tk.35,640 per quarter Labour – employer costs = Tk.19,800 per month X 40% = Tk.7,920 per month or Tk.23,760 per quarter Labour – employer costs only for quarter 1 = Tk.8,000 + Tk.7,920 + Tk.7,920 = Tk.23,840 5. Sales and marketing costs:

Tk.660,000 12 months = Tk.55,000

Sales revenue per month =

Sales and marketing costs = Tk.55,000 X 5% = Tk.2,750 per month or Tk.8,250 per quarter P-16. You have just been hired as a new management trainee by Earrings Unlimited, a distributor of earnings to various retail outlets located in shopping malls across the country. In the past, the company has done very little in the way of budgeting and at certain times of the year has experienced a shortage of cash. Since you are well trained in budgeting, you have decided to prepare comprehensive budgets for the upcoming second quarter in order to show management the benefits that can be gained from an integrated budgeting program. To this end, you have worked with accounting and other areas to gather the information assembled below. The company sells many styles of earrings, but all are sold for the same price-Tk.10 per pair. Actual sales of earrings for the last three months and budgeted sales for the next six months follow (in pairs of earrings): 97


January (actual) February (actual) March (actual) April (budget) May (budget)

20,000 26,000 40,000 65,000 100,000

June (budget) July (budget) August (budget) September (budget)

50,000 30,000 28,000 25,000

The concentration of sales before and during May is due to Mother‟s Day. Sufficient inventory should be on hand at the end of each month to supply 40% of the earrings sold in the following month. Suppliers are paid Tk.4 for a pair of earrings. One-half of a month‟s purchases are paid for in the month of purchase; the other half is paid for in the following month. All sales are on credit, with no discount, and payable within 15 days. The company has found, however, that only20% of a month‟s sales are collected in the month of sales. An additional 70% is collected in the following month, and the remaining 10% is collected in the second month following sales. Bad debts have been negligible. Monthly operating expenses for the company are given below: Variable: Sales commissions 4% of sales Fixed: Advertising Tk.200,000 Rent Salaries Tk.106,000 Utilities Insurance Tk.3,000 Depreciation

Tk.18,000 Tk.7,000 Tk.14,000

Insurance is paid on the annual basis, in November of each year. The company plans to purchase Tk.16,000 in new equipment during May and Tk.40,000 in new equipment during June, both purchases will be for cash. The company declares dividends of Tk.15,000 each quarter, payable in the first month of the following quarter. A listing of the company‟s ledger accounts as of March 31 is given below: Liabilities and Stockholders‟ Taka Equity Accounts payable 100,000 Dividends payable 15,000

Capital stock Retained earnings Total liabilities and stockholders‟ equity

Assets

Cash Accounts receivable (Tk.26,000 February sales; Tk.320,000 March sales) 800,000 Inventory 580,000 Prepaid insurance Property and equipment (net) ________ 1,495,000 Total assets

Taka 74,000

346,000 104,000 21,000 950,000 ________ 1,495,000

The company maintains a minimum cash balance of Tk.50,000. All borrowing is done at the beginning of a month; any repayments are made at the end of a month. The annual interest rate is 12%. Interest is computed and paid at the end of each quarter on all loans outstanding during the quarter.

98


Required: Prepare the following budget for the quarter ending June 30. (a) (i) A sales budget, by month and in total. (ii) A schedule of expected cash collections from sales, by month and in total. (iii) A merchandise purchases budget in units and in takas. Show the budget by month and in total. (iv) A schedule of expected cash disbursements for merchandise purchases, by month and in total. (b) A cash budget. Show the budget by month and in total. Determine any borrowing that would be needed to maintain the minimum cash balance of Tk.50,000. (c) A budgeted income statement for the quarter ending June 30. Use the contribution approach. Solution: (a) (i)

Budgeted sales unit Selling price per unit (Tk.) Total sales (Tk.)

Earrings Unlimited Sales budget April May 65,000 1,00,000 10 10 6,50,000 10,00,000

June 50,000 10 5,00,00

Quarter 2,15,000 10 21,50,000

May Tk. -

June Tk. -

Quarter Tk. 26,000

40,000

-

3,20,000

4,55,000

65,000

6,50,000

2,00,000

7,00,000

9,00,000

-

1,00,000

1,00,000

6,95,000

8,65,000

19,96,000

April Tk. 65000 40,000

May Tk. 100,000 20,000

June Tk. 50,000 12,000

Quarter Tk. 2,15,000 12,000

105000 26,000 79,000 316,000

120,000 40,000 80,000 320,000

62,000 20,000 42,000 168,000

227,000 26,000 201,000 804,000

(ii) Schedule of expected cash collections from sales: April Tk. From February sales 26,000 (Tk.26,00,000 X 10%) From March sales 2,80,000 (Tk.4,00,000 X 70%, 10%) From April sales 1,30,000 (Tk.6,50,000 X 20X,70%,10%) From May sales (Tk.10,00,000X20%,70%,10%) From June sales (Tk.5,00,000 X 20%,70%,10%) Total cash collections 4,36,000 (iii) Merchandise purchase budget:

Budgeted sales unit Add. Desired ending inventory (40% of following month sales) Total needs Less. Beginning inventory Required purchases (Units) Required purchases (Tk.) @ 4 99


(iv) Schedule of expected cash disbursements for merchandise purchases: April May June Tk. Tk. Tk. For May purchases 100,000 (Accounts payable, March 31) For April purchases 158,000 158,000 For May purchases 160,000 160,000 For June purchases 84,000 Total cash payments 258,000 318,000 244,000

Quarter Tk. 100,000 316,000 320,000 84,000 820,000

(b) Earrings Unlimited Cash Budget For the quarter ended June 30

Cash balance, beginning Add. Collection from sales Total cash available Less. Cash disbursements Payment for purchases Advertising Salaries Rent Commission (4% of sales) Utilities Purchases of equipment Dividends paid Total cash disbursements Excess (deficiency) of cash Financing: Borrowings Repayments Interest Total financing Cash balance, ending

April Tk. 74,000 436,000 510,000

May Tk. 50,000 695,000 745,000

June Tk. 50,000 865,000 915,000

Quarter Tk. 74,000 1996,000 2070,000

258,000 200,000 106,000 18,000 26,000 7,000 15,000 630,000 (120,000)

318,000 200,000 106,000 18,000 40,000 7,000 16,000 ______705,000 40,000

244,000 200,000 106,000 18,000 20,000 7,000 40,000 ______635,000 280,000

820,000 600,000 318,000 54,000 86,000 21,000 56,000 15,000 1970,000 100,000

170,000 _____170,000 50,000

10,000 _____10,000 50,000

(180,000) (5,300) (185,300) 94,700

180,000 (180,000) (5,300) (5,300 94,700

(c) Earrings Unlimited Budgeted Income Statement For the quarter ended June 30 Particulars Sales revenue Less. variable expenses: Cost of goods sold (215,000 X Tk.4) Commission @ 4% of sales Total variable costs Contribution margin

Taka

Taka 21,50,000

860,000 86,000 946,000 12,04,000 100


Less. Fixed expenses: Advertising (Tk.200,000 X 3) Salaries (Tk.106,000 X 3) Insurance (Tk.3,000 X 3) Rent (Tk.18,000 X 3) Utilities (Tk.7,000 X 3) Depreciation (Tk.14,000 X 3) Total fixed expenses Net operating income Less. Interest expense Net income

600,000 318,000 9,000 54,000 21,000 42,000 10,44,000 1,60,000 5,300 154,700

P-17. Crossman Corporation, a rapidly expanding crossbow distributor to retail outlets, is in the process of formulating plans for next year. Ms. Ismat Jahan, Director of Marketing, has completed her sales budget and is confident that sales estimates will be met or exceeded. The following budgeted sales figures show the growth expected and will provide the basis for planning within other corporate departments. Budgeted sales are: January February March April May June

Tk.18,00,000 Tk.20,00,000 Tk.18,00,000 Tk.22,00,000 Tk.25,00,000 Tk.28,00,000

July August September October November December

Tk.30,00,000 Tk.30,00,000 Tk.32,00,000 Tk.32,00,000 Tk.30,00,000 Tk.34,00,000

Mr. Shaad Hossain, Management Accountant, has been given the responsibility for formulating the cash budget, a critical task during a period of rapid expansion. The following information provided by operating managers will be used in preparing the cash budget. (a) Crossman collects 60% of credit sales in the month after the sale and 40% in the second month after the sale. Uncollectible accounts are negligible. (b) The purchase cost of crossbows equals 50% of sales. Sixty percent of the crossbows are received one month prior to sale and 40% are received during the month of sale. (c) Prior experience shows that 80% of accounts payable are paid by Crossman one month after receipt of the purchased crossbows and the remaining 20% are paid the second month after receipt. (d) Hourly wages, including fringe benefits, depend on sales volume and are equal to 20% of the current monthâ€&#x;s sales. These wages are paid in the month incurred. (e) General and administrative expenses are budgeted to be Tk.25,40,000 for the year. The composition of these expenses is given below. All of these expenses are incurred evenly throughout the year except the property taxes. property taxes are paid in four equal installments in the last month of each quarter. Salaries Tk.4,80,000 Promotion Tk.6,60,000 Property taxes Tk.2,40,000 Insurance Tk.3,60,000 Utilities Tk.3,00,000 Depreciation Tk.6,00,000 Total Tk.26,40,000

101


(f) Income tax payments are made by Crossman in the first month of each quarter based on the income for the prior quarter. Crossman‟s income tax rate is 40%. Crossman‟s net operating income for the first quarter is projected to be Tk.6,12,000. (g) Equipment and warehouse facilities are being acquired to support the company‟s rapidly growing sales. Purchases of equipment and facilities are budgeted at Tk.28,000 for April and Tk.3,24,000 for May. (h) Crossman has a corporate policy of maintaining an end-of-month cash balance of Tk.1,00,000. Cash is borrowed or invested monthly, as needed, to maintain this balance. Interest expense on borrowed funds is budgeted at Tk.8,000 for the second quarter, all of which will be paid during June. Required: Prepare a cash budget for Crossman Corporation by month and in total for the quarter ended June 30. Be sure that all receipts, disbursements and borrowing/ investing amounts are shown for each month. Ignore any interest income associated with amounts invested. Solution:

Cash balance, beginning Add. Cash receipts (w1) Total cash available Less. Cash disbursements Payment for purchases (w2) Wages (20% of sales) General and admin. (w3) Income taxes (w4) Equipment and facilities Total cash disbursements Excess (deficiency) of cash available over disbursements Financing Borrowings Repayments Interest Invested funds Total financing Cash balance, ending

Crossman Corporation Cash budget April May Tk. Tk. 100,000 100,000 18,80,000 20,40,000 19,80,000 21,40,000 10,04,000 4,40,000 1,50,000 4,08,000 28,000 20,30,000

June Tk. 100,000 23,80,000 24,80,000

Quarter Tk. 100,000 63,00,000 64,00,000

11,56,000 13,10,000 5,00,000 5,60,000 1,50,000 2,10,000 3,24,000 _______21,30,000 20,80,000

34,70,000 15,00,000 5,10,000 4,08,000 3,52,000 62,40,000

(50,000)

10,000

4,00,000

1,60,000

1,50,000 ______1,50,000 1,00,000

90,000 _____90,000 1,00,000

(240,000) (8,000) (52,000) (300,000) 1,00,000

2,40,000 (240,000) (8,000) (52,000) (60,000) 1,00,000

May Tk. 7,20,000 13,20,00 20,40,000

June Tk. 8,80,000 15,00,000 23,80,000

Quarter Tk. 800,000 18,00,000 22,00,000 15,00,000 63,00,000

Workings: 1. Cash receipts from sales:

February sales (20,00,000X40%) March sales (18,00,000 X 60%, 40%) April sales (22,00,000 X 60%, 40%) May sales (25,00,000 X 60%) Total cash receipts

April Tk. 800,000 10,80,000 18,80,000

102


2. Payment to suppliers: Determination of cost of purchases: February March Tk. Tk. 50% of sales 10,00,000 9,00,000

April Tk. 11,00,000

May June Tk. Tk. 2,50,000 14,00,000

July Tk. 15,00,000

Budgeted purchases:

For this month sales @ 40% For next month sales @ 60% Total

February March April Tk. Tk. Tk. 400,000 360,000 440,000 540,000 660,000 750,000 940000 1020000 1190000

May June Tk. Tk. 500,000 560,000 840,000 900,000 1340000 1460000

Payment for purchases:

February purchases (,940,000X20%) March purchases (10,20,000X80%,20%) April purchases (11,90,000X80%,20%) May purchases (13,40,000X80%,20%) Total

April May June Quarter Tk. Tk. Tk. Tk. 188,000 816,000 204,000 - 952,000 238,000 - 1,072,000 1004,000 1156,000 1310,000 3470,000

3. General and administrative expenses:

Salaries (1/12 of annual) Promotion (1/12 of annual) Property taxes (1/4 of annual) Insurance (1/12 of annual) Utilities (1/12 of annual) Depreciation (Non-cash item) Total

April Tk. 40,000 55,000 30,000 25,000 150,000

May Tk. 40,000 55,000 30,000 25,000 150,000

June Quarter Tk. Tk. 40,000 55,000 60,000 30,000 25,000 210,000 510,000

4. Income tax:

Tk.6,12,000 1  0.4 = Tk.10,20,000

Income before tax =

Income tax = Tk.10,20,000 X 40% = Tk.4,08,000 P-18. You are given following figures of annual production of a particular factory in an industrial area. Calculate the trend values by the method of least squares and estimate the probable production for the year 2021.

103


Year 2013 2014 2015 2016 2017

Production units (in‟000) 12 18 20 23 27

Solution: Calculation of trend values by least squares method Year 2013 2014 2015 2016 2017 N=5

Production (Y) 12 18 20 23 27 ∑Y = 100

Taking deviation from 2015 (X) -2 -1 0 1 2 ∑X = 0

XY

X2

-24 -18 0 23 54 ∑XY = 35

4 1 0 1 4 ∑X2 = 10

Trend values YC 13.0 16.5 20.0 23.5 27.0 ∑YC = 100

The equation of trend line is, YC = a + bx Here, a=

Y

N 100 = 5 = 20 b=

 XY X

2

35 10 = 3.5 YC = 20 + 3.5 x =

Estimation of trend values: Y2013 = 20 + 3.5 x (-2) = 20 - 7 = 13 Y2014 = 20 + 3.5 x (-1) = 20 – 3.5 = 16.5 104


Y2015 = 20 + 3.5 x 0 = 20 + 0 = 20 Y2016 = 20 + 3.5 x 1 = 20 + 3.5 = 23.5 Y2017 = 20 + 3.5 x 2 = 20 + 7 = 27 Estimation of production for the year 2021: Y2021 = 20 + 3.5 x 6 = 20 + 21 = 41 P-19. Fit a straight line trend by the method of lest squares to the following data and fit the trend values: Year 2012 2013 2014 2015 2016 2017

Sales units (in‟000) 10 13 16 21 24 30

Solution: Calculation of trend values by least squares method Year 2012 2013 2014 2015 2016 2017 N=6

Sales (Y) 10 13 16 21 24 30 ∑Y = 114

Taking deviation from 2014 (X) -2 -1 0 1 2 3 ∑X = 3

XY

X2

-20 -13 0 21 48 90 ∑XY = 126

4 1 0 1 4 9 ∑X2 = 19

Trend values YC 9.15 13.09 17.03 20.97 24.91 28.85 ∑YC = 114

The equation of trend line is, YC = a + bx Since ∑X is not zero, we have to solve the two normal equations simultaneously. ∑Y = Na + b ∑X => 114 = 6 a + 3 b …………………… (i) 105


∑XY = a ∑X + b ∑X2 => 126 = 3 a + 19 b …………………. (ii) Solving the equations (i) and (ii) we get, a = 17.03 and b = 3.94 The equation of straight line trend is, YC = 17.03 + 3.94 x Estimation of trend values: Y2012 = 17.03 + 3.94 x (-2) = 9.15 Y2013 = 17.03 + 3.94 x (-1) = 13.09 Y2014 = 17.03 + 3.94 x (-0) = 17.03 Y2015 = 17.03 + 3.94 x (1) = 20.97 Y2016 = 17.03 + 3.94 x (2) = 24.91 Y2017 = 17.03 + 3.94 x (3) = 28.85 P-20. A business wishes to forecast its sales for the coming year 2017 using moving averages to establish a straight-line trend and seasonal variations. The accountant has assumed that sales have seasonal effect, i.e. summer season and winter season. Seasonal sales for the past four years have been given below: Year 2015 2016 2017 2018

Summer sales (Tk.‟000) 150 200 300 450

Winter sales (Tk.‟000) 50 100 200 --

Required: (a) Calculate a trend line based on two-season moving average. (b) Calculate the average increase in sales each season. (c) Calculate seasonal variation in sales. Solution:

106


(a) Season & Year

Summer 2015

Actual sales

Two-season moving total

A Tk.‟000 150

B Tk.‟000

Seasonal moving average C = B÷2 Tk.‟000

200

100

Winter 2015

50

Summer 2016

200

Winter 2016

100

Summer 2017

300

250

E=A–D Tk.‟000

112.5

- 62.5

137.5

+ 62.5

175

- 75

225

+ 75

287.5

- 87.5

150

400

Summer 2018

Seasonal variation

125

300

Winter 2017

Center the moving average D Tk.‟000

200

500

250

650

325

200 450

Tk.287,500  Tk.112,500 4 seasons = Tk.43,750 each season

(b) The average increase in sales each season =

(c) The seasonal variation in sales calculated as follows: Year Summer season Winter season Tk.‟000 Tk.‟000 2015 -62.5 2016 +62.5 -75.0 2017 +75.0 -87.5 Total variations 137.5 225.0

Number of measurements Average seasonal variation Reduced to zero (Share equally) Seasonal variation

Summer season 2 +68.75 +3.125 +71.875

Winter season 3 +75.00 +3.125 78.125

Total +6.25 -6.25 0.0

P-21. The accountant of Camberwell Electronics Company believes that the identification of the variable and fixed components of the firm‟s costs will enable the firm to make better planning and control decisions. Among the costs the accountant is concerned about is the behavior of indirect materials cost. She believes that machine hours are a cost driver for indirect materials costs. A member of the accountant‟s staff has suggested that regression analysis be used to determine the cost behavior of indirect materials. The following regression equation was developed from 40 pairs of observations:

107


S = Tk.200 + Tk.4H where S = total monthly costs of indirect materials H = machine hours per month Required: (a) Explain the meaning of „200‟ and „4‟ in the regression equation S = Tk.200 + Tk.4H. (b) Calculate the estimated cost of indirect materials if 900 machine hours are to be used during a month. (c) To determine the validity of the cost estimate calculated in requirement (ii), what questions would you ask the accountant about the data used for the regression? (d) Consider three other activities that could be used as cost drivers to predict the total monthly costs of indirect materials. Solution: (a) The regression equation S = Tk.200 + Tk.4H means that the intercept on the vertical axis is Tk.200. It represents the portion of indirect materials cost that does not vary with machine hours, when operating within the relevant range. The slope of the regression line is Tk.4 per machine hour. For every machine hour, Tk.4 of indirect material costs is expected to be incurred. (b) Estimated cost of indirect materials, S = Tk.200 + (Tk.4 X 900) = Tk.200 + Tk.3,600 = Tk.3,800 (c) Several questions should be asked: - Do the observations contain any outliers, or are they all representative of normal operations? - Are there any mismatched the periods in the data? Are all of the indirect material cost observations matched properly with the machine hour observations? - Are there any allocated costs included in the indirect material cost data? - Are the cost data affected by inflation? (d) The choice of cost driver should reflect the nature of the production process. Other cost drivers include direct labor hours or direct labor cost if the production process is labor intensive and the consumption of indirect materials is related to labor activities. Alternative the number of units produced could be a suitable cost driver, if each unit uses much the same amount/ cost of indirect material. P-22. The owner of the ABC Company has asked his accountant to prepare a model for forecasting monthly sales on the basis of the amount of advertising spent. The accountant gathered the following information from the company‟s financial records for the last 4 months: Month Advertising Sales (Tk.‟000) (Tk.‟000) January 150 250 February 100 150 March 200 300 April 250 200 108


Required: (a) Estimate the parameters in the following simple linear regression: Y = a + bX Where, X is advertising and Y is sales. (b) Compute the coefficient of determination and explain what it means. (c) If advertising expenses for next month are Tk.400,000, what is the point estimate forecasted by the regression model? Solution: (a) The worksheet to compute the regression parameters Month January February March April N=4

X 150 100 200 250 ∑X = 700

Y 250 150 300 200 ∑Y = 900

The formula for regression line is, Y = a + bx Here, b=

N  XY -  X Y

N (X 2 )   (X )2

(4 X 162,500)  (700 X 900) (4 X 135,000)  (700) 2 650,000  630,000 = 540,000  490,000 20,000 = 50,000 = 0.4

=

a=

 Y - b X

N 900  (0.4 X 700) = 4 900  280 = 4 = 155 Therefore, the estimated regression line is, Y = 155 + 0.4 X 109

X2 22,500 10,000 40,000 62,500 ∑X2 = 135,000

Y2 62,500 22,500 90,000 40,000 ∑Y2 = 215,000

XY 37,500 15,000 60,000 50,000 ∑XY = 162,500


(b) The coefficient of determination =

Explained sum of squares Total sum of squares

Here, Explained sum of squares = b (N ∑XY - ∑X ∑Y) = 0.4 {(4 X 162,500) – (700 X 900)} = 0.4 (650,000 – 630,000) = 8,000 Total sum of squares = N ∑Y2 – (∑Y)2 = (4 X 215,000) – (900)2 = 860,000 – 810,000 = 50,000

8,000 50,000 = 0.16

The coefficient of determination =

Coefficient of determination is 0.16 means that 16% of the variation in monthly sales is explained by the amount of advertising. (c) If advertising is expected to be Tk.400,000, then Y = 155 + 0.4 X = 155 + 0.4 X 400 = 155 + 160 = 315 Therefore, forecasted sales = Tk.315,000 P-23. Ajex Company has an exclusive franchise to purchase a product from the manufacturer and distribute it on retail level. As an aid in planning, the company has decided to start using the contribution approach to the income statement internally. To have data to prepare such a statement, the company has analyzed its expenses and develop the following cost formulas: Cost Cost of goods sold Advertising expenses Sales Commission Shipping expenses Administrative salaries Insurance expenses Depreciation expenses

Cost formula Tk. 35/- per unit sold Tk. 2,10,000/- per quarter 6% of sales ? Tk. 1,45,000/- per quarter Tk. 9,000/- per quarter Tk. 304,000/- per year

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Management has concluded that shipping expenses is a mixed cost, containing both variable and fixed cost elements. Units sold and the related shipping expense over the last eight quarters are as follows: Quarter Year-2016 1st Q. 2nd Q. 3rd Q. 4th Q. Year-2017 1st Q. 2nd Q. 3rd Q. 4th Q.

Unit sold 10,000 16,000 18,000 15,000

Shipping expenses (Tk.) 1,19,000/1,75,000/1,90,000/1,64,000/-

11,000 17,000 20,000 13,000

1,30,000/1,85,000/2,10,000/1,47,000/-

Ajex Companyâ€&#x;s president would like a cost formula derived for shipping expenses so that a budgeted income statement using the contribution approach can be prepared for the next quarter. Required: (a) Using the least square regression method; estimate a cost formula for shipping expenses. (b) In the 1st quarter of year 2018, the company plans to sell 12,000 units at Tk.100 per unit. Prepare an income statement for the quarter using the contribution format. Solution: (a) Separation of cost using least square regression method Units sold (X) In Thousand

Shipping cost (Y)

XY

X2

Year 2016 1st Q. 2nd Q. 3rd Q. 4th Q.

10 16 18 15

119,000 175,000 190,000 164,000

1,190,000 2,800,000 3,420,000 2,460,000

100 256 324 225

Year 2017 1st Q. 2nd Q. 3rd Q. 4th Q. Total

11 17 20 13 120

130,000 185,000 210,000 147,000 1,320,000

1,430,000 3,145,000 4,200,000 1,911,000 20,556,000

121 289 400 169 1,884

Quarter

The cost formula for shipping expense is, Y = a + bx

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Here, b=

N  XY -  X Y

N (X 2 )   (X )2

(8 X 20,556,000)  (120 X 1,320,000) (8 X 1,884)  (120) 2 = 9,000

=

a=

 Y - b X

N 1,320,000  (9,000 X 120) = 8 = 30,000 Therefore, the cost formula for shipping expense is, Y = 30,000 + 9 X (b) Ajex Company Income Statement In the 1st quarter of year 2018 Tk. Sales Less. variable expenses: Cost of goods sold (12,000 units X Tk.35) Sales commission (Tk.1,200,000 X 6%) Shipping expenses (12,000 units X Tk.9) Total variable expenses Contribution margin Less. Fixed expenses: Advertising expenses Shipping expenses Administrative salary Insurance expenses Depreciation expenses Total fixed expenses Net income

Tk. 1,200,0000

420,000 72,000 108,000 600,000 600,000 210,000 30,000 145,000 9,000 76,000 470,000 130,000

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EXERCISES E-1. PHI is a retail company which sells various mobile phones. PHI operates 10 retail stores in Bangladesh. Most sales are for cash but PHI also supplies mobile phones on credit to corporate customers. On 1 January 2015, the Finance Director compiled forecast data for the current financial year ending 31 December 2015 as follows Notes Tk. million Sales revenue 1,2 725 Purchases 3,4 370 Other costs 5 325 Capital expenditure 6 30 Dividend 7 20 Notes: 1. Retail sales represent 70% of all sales revenue and all retail sales are on a cash basis. The remaining 30% of sales are to corporate customers on credit. 2. Corporate customers are given 60 days credit and largely kept to these credit terms throughout the previous year. At the time of drawing up the forecast data above, there was no reason to assume that this would change in the coming year. 3. Purchases are made on 120 days credit. 4. Inventory value is expected to remain the same throughout the year ending 31 December 2015. Therefore the purchases figure identified above is equivalent to cost of goods sold. 5. Within „other costs‟ is depreciation of Tk.40 million. Apart from depreciation, „other costs‟ should be assumed to be paid as incurred. 6. Capital expenditure should also be assumed to be paid as incurred. 7. The dividend is to be paid on 25 December 2015. Additional information: On 1 January 2015, opening balances for working capital were as follows: • Accounts receivable: Tk.37.2 million • Accounts payable: Tk.124.9 million • Inventory: Tk.42.0 million • The opening cash balance was Tk.50 million on 1 January 2015 • PHI has been careful to retain cash resources and has not needed to arrange any back-up bank facilities in addition to its long term bank borrowings • Ignore taxation Since 1 January 2015 when the forecast was prepared, market conditions have deteriorated. Indeed, a large competitor company recently went into receivership due largely to liquidity issue following demand by key suppliers for cash on delivery. The directors of PHI are keen to seek reassurance from their Finance Director that PHI has sufficient liquidity to withstand the liquidity pressures created by this type of risk event. In particular, the Finance Director of PHI has been asked to carry out an urgent review of the liquidity impact of each of the following possible scenarios in respect of the year ending 31 December 2015. Assume all other underlying data remain unchanged. 113


Scenario 1 Scenario 2 Scenario 3 Sales revenue falls to Sales revenue and Sales revenue and purchases as Tk.630 million but the purchases as for scenario 1. for scenario 1. proportion of retail sales AND AND remains unchanged. Accounts receivable days All suppliers demand cash on AND rise to 100 days. delivery. Purchases fall to Tk.321 Note: Accounts receivable days million. remain unchanged at 60 days. Required: (a) Prepare a cash flow forecast for the year ending 31 December 2015 based on the forecast financial data available on 1 January 2015. (b) Evaluate the impact on the borrowing requirement of PHI for each of scenarios 1, 2 and 3 given above. (c) Advise PHI how the liquidity challenges it faces might affect its approach to the management of working capital. CMA Adapted – December 2016 E-2. Auxiliary Ltd, a manufacturing company, having a capacity of 700,000 units has prepared the following cost sheet: Per Unit ($) Direct Material 30 Direct wages 12 Factory overheads (50% variable) 30 Selling & Administrative overheads (2/3rd fixed) 18 Selling price 120 During the year 2013-14 the sales volume achieved by the company was 600,000 units. The company has launched an expensive program, the details of which are as under: (i) The capacity will be increased to 1,200,000 units. (ii) The additional fixed overheads will amount to $5,000,000 up to 1,000,000 units and will increase by $2,500,000 more beyond 1,000,000 units. (iii) The cost of investment of expansion is $10,000,000 which is proposed to be financed through Bank borrowings carrying interest at 15% p.a. (iv) The average depreciation rate on the new investment is 15% based on straight line method. After the expansion is put through, the company has two alternatives for operations: (i) Sales can be increased up to 1,000,000 units by spending $1,000,000 on special advertisement campaign to explore new market. Or (ii) Sales can be increased to 1,200,000 units subject to the following: • By an overall reduction $10 per unit on all the units sold. • By increasing the variable selling and administrative expenses by 8%. • The direct material costs would go down by 1.5% due to discount on bulk purchasing. Required: (i) Construct a Flexible Budget at the level of 600,000, 1,000,000 and 1,200,000 unit of production. (ii) Calculate the break-even point before and after expansion. (iii) Advise the optimum level of output for expansion. CMA Adapted – June 2016 114


E-3. Mrs. Karim is the manager of an airport of gift shop, Karim News and Gifts. From the following data, Mrs. Karim wants a cash budget showing expected cash receipts and disbursements for the month of April, and the cash balance expected as of April 30, 2009. • Bank note due April 10; Tk.90,000 plus 4,500 interest. • Depreciation for April; Tk.2,100. • Two-year insurance policy due April 14 for renewal; 1,500 to be paid in cash. • Planned cash balance, March 31, 2009; Tk.80,000. • Merchandise purchases for April; Tk.4,50,000, 40% paid in month of purchase, 60% paid in next month. • Customer receivables as of march 31; Tk.60,000 from February sales, Tk.4,50,000 from march sales. • Payrolls due in April; Tk.90,000. • Other expenses for April, payable in April; Tk.45,000. • Accrued taxes for April, payable in June; Tk.7,500. • Sales for April; Tk.10,00,000, half collected in month of sales, 40% in next month, 10% in third month. • Accounts payable March 31, 2009; Tk.4,60,000. Required: Prepare the cash budget. CMA Adapted – August 2015 E-4. Keya sales Inc., sells garden supplies. Management is planning its cash needs for the second quarter. The company usually has to borrow money during this quarter to support peak sales of lawn care equipment, which occur during May. The following information has been assembled to assist in preparing cash budget for the quarter: (a) Budgeted monthly absorption costing income statements for April-July are: Particulars (figures in Taka) April May June July Sales 600,000 900,000 500,000 400,000 Cost of goods sold 420,000 630,000 350,000 280,000 Gross margin 180,000 270,000 150,000 120,000 Less: operating expenses: Selling expense 79,000 120,000 62,000 51,000 Administrative expense* 45,000 52,000 41,000 38,000 Total operating expenses 124,000 172,000 103,000 89,000 Net operating income` 56,000 98,000 47,000 31,000 *Includes Tk.20,000 of depreciation each month. (b) Sales are 20% for cash and 80% on account. (c) Sales on account are collected over a three-month period with 10% collected in the month of sale; 70% collected in the first month following the month of sale; and the remaining 20% collected in the second month following the month of sale. February‟s sales total Tk.200,000, and March‟s sales total tk.300,000. (d) Inventory purchases are paid for within 15 days. therefore, 50% of a month‟s inventory purchases are paid for in the month of purchase. the remaining 50% is paid in the following month. Accounts payable at March 31 for inventory purchases during March total Tk.126,000. (e) Each month‟s ending inventory must equal 20% of the cost of the merchandise to be sold in the following month. The merchandise inventory at March 31 is Tk.84,000. (f) Dividends of Tk.49,000 will be declared and paid in April. (g) Land costing Tk.16,000 will be purchased for cash in May. 115


(h) The cash balance at March 31 is Tk.52,000; the company must maintain a cash balance of at least Tk.40,000. (i) The company can borrow from its bank as needed to bolster the Cash account. Borrowings and repayments must be in multiplies of Tk.1,000. All borrowings take place at the beginning of a month, and all repayments are made at the end of a month. The annual interest rate is 12%. Compute interest on whole months (1/12, 2/12, and so forth). Required: (a) Prepare a schedule of expected cash collections for April, May, and June, and for the quarter in total. (b) Prepare the following for merchandise inventory: (i) A merchandise purchases budget for April, May, and June. (ii) A schedule of expected cash disbursements for merchandise purchases for April, May, and June, and for the quarter in total. (c) Prepare a cash budget for April, may, and June as well as in total for the quarter. Show borrowings from the company‟s bank and repayments to the bank as needed to maintain the minimum cash balance. CMA Adapted – April 2015 E-5. Jahan Cmpany, an office supplies specially store, prepare its master budget on a quarterly basis. The following data have been assembled to assist in preparing the master budget for the first quarter: a) As of December 31 (the end of the prior quarter), the company‟s balance sheet is given below: Assets Taka Cash 48,000 Accounts Receivable 224,000 Inventory 60,000 Building & equipment, net of depreciation 370,000 Total assets 702,000 Liabilities and Equity Accounts payable, supplies 93,000 Paid up capital 500,000 Retained earnings 109,000 Total liabilities and equity 702,000 b) Actual sales for December and budgeted sales for the next four months are as follows: December (actual) Tk.280,000 January Tk.400,000 February Tk.600,000 March Tk.300,000 April Tk.200,000 c) Sales are 20% for cash and 80% on credit. All payments on credit sales are collected in the month following sale. The accounts receivable at December 31 are a result of December credit sales. d) The company‟s gross margin is 40% of sales. (In other words, cost of goods sold is 60% of sales.) e) Each month‟s ending inventory should equal 25% of the following month‟s cost of goods sold. f) One-half of a month‟s inventory purchases is paid for in the month of purchase; the other half is paid in the following month. 116


g) Monthly expenses are budgeted as follows: salaries and wages, Tk.27,000 per month; advertising, Tk.70,000 per month; shipping, 5% of sales; other expenses, 3% of sales, Depreciation, including depreciation on new assets acquired during the quarter, will be Tk.42,000 for the quarter. h) During February, the company will purchase a new copy machine for Tk.1,700 cash. During march, other equipment will be purchased for cash at a cost of Tk.84,500. i) During January, the company will declare and pay Tk.45,000 in cash dividends. j) The company must maintain a minimum cash balance of Tk.30,000. An open line of credit is available at HSBC bank for any borrowing that may be needed during the quarter. all borrowing is done at the beginning of a month, and all repayments are made at the end of a month. Borrowings and repayments of principal must be in multiplies of Tk.1,000. Interest is paid only at the time of payment of principal. The annual interest rate is 12%. (Figure interest on whole months, e.g., 1/12, 2/12.) Required: (i) Prepare a cash budget for the first quarter. (Support your budget with schedules showing budgeted cash collections, inventory purchase and budgeted cash payments for inventory purchases.) (ii) Prepare an absorption costing budgeted income statement for the quarter ending March 31. (iii) Prepare budgeted balance sheet as of march 31. CMA Adapted – December 2014 E-6. The balance sheet of RACO Inc., a distributor of photographic supplies, as of March 31, 2014 is given below: RACO Inc. Balance sheet As of March 31, 2014 Assets Taka Cash 8,000 Accounts Receivable 72,000 Inventory 30,000 Building & equipment, net of depreciation 500,000 Total assets 610,000 Liabilities and Equity Accounts payable, supplies Bond payable Paid up capital Retained earnings Total liabilities and equity

90,000 15,000 420,000 85,000 610,000

RACO Inc. has not budgeted previously, and for this reason it is limiting its master budget planning horizon to just one month ahead- namely, April. The company has assembled the following budgeted data relating to April 2014: (a) Sales are budgeted at Tk.250,000. Of these sales, Tk.60,000 will be for cash; the remainder will be credit sales. One-half of a monthâ€&#x;s credit sales are collected in the month the sales are made, and the remainder is collected in the month following. All of the March 31 accounts receivable will be collected in April.

117


(b) Purchases of inventory are expected to total Tk.200,000 during April. These purchases will be on account. Forty percent of all inventory purchases are paid for in the month of purchase; the remainder is paid in the following month. All of the March 31 accounts payable to supplies will be paid during April. (c) The April 30 inventory balance is budgeted at Tk.40,000. (d) Operating expenses for April are budgeted at Tk.51,000; exclusive of depreciation. These expenses will be paid in cash. Depreciation is budgeted at Tk.2,000 for the month of April. (e) The bond payable on the March 31 balance sheet will be paid during April. The company‟s interest expense for April (on all borrowings) will be Tk.500, which will be paid in cash. (f) New warehouse equipment costing Tk.9,000 will be purchased for cash during April. (g) During April, the company will borrow Tk.18,000 from its bank by giving a new bond payable to the bank for that amount. The new bond will be due in one year. Required: (i) Prepare a cash budget for April 2014. Support your budget with schedules showing budgeted cash receipts from sales and budgeted cash payments for inventory purchases. (ii) Prepare a budgeted income statement for April 2014. (iii) Prepare a budgeted balance sheet as of April 30, 2014. CMA Adapted – August 2014 E-7. The budget prices for direct materials and labor per unit of finished product are Tk.13.00 and Tk.5.00 respectively. The production manager is delighted about the following data: Master (Static) Budget Direct material Tk.10,40,000 Direct labor Tk.4,00,000 Is the manager‟s happiness justified?

Actual Costs Tk.9,80,000 Tk.3,76,000

Variance Tk.60,000F Tk.24,000F

Required: Prepare a report that might provide a more detailed explanation of why the static (master) budget was not achieved. Good output was 68,000 units. CMA Adapted – December 2013 E-8. Berwin Ltd is a manufacturer of small industrial tools with annual sales of approximately $7 million. Sales growth has been steady during the year and there is no evidence of cyclical demand. Production has increased gradually during the year and has been evenly distributed throughout each month. Carla Viller, the accountant, has designed and implemented a new budget system in response to concerns voiced by CEO George Berwin. Carla prepared an annual budget that has been divided into 12 equal segments; this budget can be used to assist in the timely evaluation of monthly performance. George was visibly upset upon receiving the May performance report for the machining department. He exclaimed: ‟How can they be efficient enough to produce nine extra units every working day and still miss the budget by $300 per day!‟ Gene Jordan, the supervisor of the machining department, could not understand „all the red ink‟ when he knew that the department had operated more 118


efficiently in May than it had done in months. Gene stated: „I was expecting a pat on the back. Instead, the boss tore me apart. What‟s more, I don‟t even know why!‟ Budgeted Volume in units Variable manufacturing costs: Direct materials Direct labour Variable overheads Total variable Costs

Fixed manufacturing Costs: Indirect labour Depreciation Taxes Insurance Other Total fixed costs

Actual

Variance

3,000

3,185

185 F

$24,000

$24,843

$ 843 U

27,750 33,300 $85,050

29,302 35,035 $89,180

1,552 U 1,735 U $4,130 U

$ 3,300 1,500 300 240 930 $ 6,270

$ 3,334 1,500 300 240 1,027 $ 6,401

$ 34 U 0 0 0 97 U $ 131 U

$ 2,400 3,600 $6,000 $97,320

$ 3,728 4,075 $ 7,803 $103,384

$1,328 U 475 U $1,803 U $6,064 U

Corporate costs: Research and development Selling and administrative Total corporate costs Total costs

Required (a) Discuss the strengths and weaknesses of the new budgetary system. (b) Identify the weaknesses of the performance report and explain how it should be revised to eliminate each weakness. (c) Prepare a revised report for the machining department using the May data. (d) What other changes would you make to improve Berwin‟s budgetary system? CMA Adapted – August 2013 E-9. NazAsh Pvt. Ltd. has had great difficulty in controlling manufacturing overhead costs. At a recent convention, the Managing Director heard about a control device for overhead costs known as a flexible budget, and he has hired you to implement the budgeting program in NazAsh Company. After some effort, you have developed the following cost formulas for the company‟s Machining Department. These costs are base on a normal operating range of 10,000 to 20,000 machine-hours per month: Overhead Cost Cost Formula Utilities………….... Tk 0.70 per machine-hour Lubricants………… Tk 1.00 per machine-hour plus Tk.8,000 per month Machine setup……. Tk 0.20 per machine-hour Indirect labor……... Tk 0.60 per machine-hour plus Tk120,000 per month Depreciation….…... Tk 32,000 per month 119


During March 2013, the first month after your preparation of the above data, the Machining Department worked 18,000 machine-hours and produced 9,000 units of product. The actual manufacturing overhead costs of this production were as follows: Items Utilities……………….……... Lubricants…………….…….. Machine setup……….……… Indirect labor………….…….. Depreciation………….……... Total manufacturing overhead costs

Taka 12,000 24,500 4,800 132,500 32,000 205,800

Fixed costs had no budget variances. The department had originally been budgeted to works 20,000 machine-hours during March 2013. Required: i. Prepare a flexible budget for the machining Department in increments of 5,000 hours. Include both variable and fixed costs in your budget. ii. Prepare an overhead performance report for the machining Department for the month of March 2013. Include both variable and fixed costs in the report (in separable sections). Show only a spending variance on the report. iii. What additional information would you need to compute an overhead efficiency variance for the department? CMA Adapted – April 2013 E-10. Urban Bank is a new small commercial bank operating in Dhaka, Bangladesh. The bank limits interest rate risk by matching the maturity of its assets to the maturity of its liabilities. By maintaining a spread between interest rates charged and interest rates paid, the bank plans to earn a small income. Management establishes a flexible budget based on interest rate for each department. The car loan department offers five-year loans. It matches certificates of deposits against car loans. Given all the uncertainty about government fiscal policy, management believes that five-year savings interest rates could vary between 2 percent and 16 percent for the coming year. The savings rate is the rate paid on CD savings account. The loan rate is the rate charged on auto loans. The following table shows the expected new demand for fixed-rate, five-year loans and new supply of fixed-rate, five-year savings accounts at various interest rates. There are no loans from previous years. Note that the department maintains a 4 percent spread between loan and savings rates to cover processing, loan default, and overhead. Loan rate (%) 6 7 8 9 10

Savings rate (%) 2 3 4 5 6

Loan demand Tk. 12,100,000 Tk. 10,000,000 Tk. 8,070,000 Tk. 6,030,000 Tk. 4,420,000

Savings supply Tk. 4,700,000 Tk. 5,420,000 Tk. 8,630,000 Tk. 9,830,000 Tk. 11,800,000

The amount of new loans granted is always the lesser of the loan demand and loan supply. For simplicity, this bank may lend 100 percent of deposits. Although rates are set nationally, the bank may pay or charge slightly different rates to limit demand or boost supply as needed in its local market. 120


The car loan department incurs processing, loan default, and overhead expenses related to these accounts. The first two expenses vary, depending on the taka amount of the accounts. The processing expense is budgeted to be 1.5% of the loan accounts. Default expense is budgeted at 1% of the amount loaned. Again, loans and savings would ideally be the same. Overhead expenses are estimated to be Tk. 30,000 for the year, regardless of the amount loaned. The following table shows an actual income statement for the Car loan department. Included are the actual loans and savings for the same period. Interest Income Interest expense Net interest income Fixed overhead Processing expense Default expense Net Income Loans Deposits

Tk. 645,766 314,360 331,406 30,200 130,522 77,800 Tk. 92,884 Tk. 8,062,000 Tk. 8,123,000

Required: (i) Calculate the processing, loan default, and overhead expenses for each possible interest rate. (ii) Create a budgeted income statement for five-year loans and deposits for the Car loan department given a savings interest rate of 4 percent. Remember to match supply and demand. (iii) Calculate the variances and provide a possible explanation. CMA Adapted – August 2012 E-11. The following data are available in a manufacturing company for a yearly period: Fixed expenses Wages and salaries Rent, rates and taxes Depreciation Sundry administrative expenses

Tk. 9,50,000 6,60,000 7,40,000 6,50,000

Semi-variable expenses (at 50% of capacity) Maintenance and repairs Indirect labour Sales department salaries etc. sundry administrative expenses

3,50,000 7,90,000 3,80,000 2,80,000

Variable expenses (at 50% of capacity) Material Labour Other expenses

121

21,70,000 20,40,000 7,90,000 98,00,000


Assume that the fixed expenses remain constant for all levels of production, semi-variable expenses remain constant between 45% and 65% of capacity, increasing by 10% between 65% and 80% capacity and by 20% between 80% and 100 capacity. Sales at various levels are: Tk. (in lakhs) 100 120 150 180 200

50% capacity 60% capacity 75% capacity 90% capacity 100% capacity

Prepare a flexible budget for the year and forecast the profit at 60%, 75%, 90% and 100% of capacity. CMA Adapted – April 2012 E-12. Unilever Ltd. wants to prepare a cash budget for the months of September through December. From the following information prepare the cash budget and state if the company will need to invest excess funds or borrow funds during these months: (1) Sales were Tk.5,00,000 in June and Tk.6,00,000 in July. Sales have been forecasted to be Tk.6,50,000, Tk.7,20,000, Tk.6,30,000, Tk.5,90,000 and Tk.5,60,000 for the months of August, September, October, November and December respectively. In the past, 10% of sales were on cash basis and the collections were 50% in the first month, 30% in the second month and 10% in the third month following the sales. (2) Every 4 months 5,000 of dividends from investments are expected. The first dividend payment was received in January. (3) Purchases are 60% of sales, 15% of which are paid in cash, 65% are paid 1 month later and the rest is paid 2 months after purchase. (4) Tk.80,000 dividends are paid twice a year in March and September. (5) Monthly rent is Tk.20,000. (6) Taxes are paid Tk.65,000 payable in December. (7) A new equipment will be purchased in October for Tk.23,000. (8) Tk.15,000 interest will be paid in November. (9) Tk.10,000 loan payments are paid every month. (10) Wages and salaries are Tk.10,000+5% of sales in each month. (11) August‟s ending cash balance is Tk.30,000. (12) The company would like to maintain a minimum cash balance of Tk.1,00,000. Required: Prepare the cash budget and state if the company will need to invest excess funds or borrow funds during the months of September, October, November, and December. CMA Adapted – April 2012 E-13. HAQ Fabrications manufactures boxes for workstations. The firm‟s standard cost sheet and the operating result of October 2010 are given below: Particulars Standard cost per Operating result unit (October 2010) Units Sales

Tk.50.00

9500 Tk.551,000 122


Variable costs: Direct materials 5 pounds @ Tk.2.40 Direct labour: 0.5 hour @ Tk.14 per hour Variable manufacturing overhead Variable selling and administrative expenses Total variable cost Contribution margin Fixed cost: Manufacturing cost Selling and administrative expenses Total fixed costs Operating Income

Tk.12.00

48,000 pounds @ Tk.3 = Tk.144,000

Tk.7.00 Tk.2.00 Tk.5.00

48,000 hour @ Tk.16 = Tk.76,800 Tk.19,000 Tk.55,100

Tk.26.00 Tk.24.00

Tk.294,900 Tk.256,100

Tk.50,000 Tk.20,000 Tk.70,000

Tk.55,000 Tk.24,000 Tk79,000 Tk.177,100

In preparing the master budget for October 2010 the firm had several expected changes from the standard cost sheet. The sales price would increase by 8%. Its suppliers notified the form that material price would increase by 5% starting October 1. The labour contract that started on October 1increased wages and benefits by 10%. Fixed manufacturing costs would increase Tk.5,000 for insurance, property taxes and salaries. For fixed selling and administrative expenses there would be a Tk.2,000 increase in manager‟s salaries. Furthermore, the firm plans to spend an additional Tk.2,000 for advertising during October 2010. The unit sales for October 2010 were expected to be 10,000 units. HAQ Fabrications uses JIT systems in all of its operations including materials acquisitions and product manufacturing. Required: (i) Prepare the master budget and flexible budget at 9,500 units and at 11,000 units for October 2010. (ii) Compute the sales volume operating income variances, flexible budget operating variance, sales price variance and flexible budget variable cost variance for October 2010. (iii) Determine the direct material price variance, direct material usage variance, direct labour rate variance and direct labour efficiency variance. CMA Adapted – December 2011 E-14. Jhonson Building Supplies are prepared to purchase and sales budget for the year 2009. All sales of Jhonson Building Supplies (JBS) are made on credit. Sales are billed twice monthly, on the 10th of the month for the last half of the prior month‟s sales and on the 20th of the month for the first half of the current month‟s sales. The terms of the sales are 2/10, net 30. Based on past experience, the collection of accounts receivable is as follows: Within the discount period On the 30th day Uncollectible 123

80% 18% 2%


The sales value of shipments for May 2009 was Tk.7,50,000. The forecasted sales for the next 4 months are: June Tk.8,00,000 July Tk.9,00,000 August Tk.9,00,000 September Tk.7,50,000 JBS‟s average markup on its products is 20% of the sales price. JBS purchases merchandise for resale to meet the current month‟s sales demand and to maintain a desired monthly ending inventory of 25% of the next month‟s sales. All purchase are on credit with terms of net 30. JBS pay for one-half of a month‟s purchases in the month of purchase and the other half in the month following the purchase. All sales and purchase occur uniformly throughout the month. Required: (i) How much cash can JBS plan to collect from accounts receivable collections during July 2009? (ii) How much can JBS plan to collect in September from sales made in August 31, 2009? (iii) Compute the budgeted value of JBS inventory on August 31, 2009. (iv) How much merchandise should JBS plan to purchase during June 2009? (v) How much should JBS budget in August 2009 fir the payment for merchandise purchased? CMA Adapted – August 2011 E-15. Comilla University offers an extensive continuing education program in many cities throughout the state. For the convenience of its faculty and administrative staff and to save costs, the university employs a supervisor to operate a motor pool. The motor pool operated with 20 vehicles until February, when an additional automobile was acquired. The motor pool furnishes gasoline, oil and other supplies for its automobiles. A mechanic does routine maintenance and minor repairs. Major repairs are done at a nearby commercial garage. Each year, the supervisor prepares an operating budget that informs the university administration of the funds needed for operating the motor pool. Depreciation (straight line) on the automobiles is recorded in the budget in order to determine the cost per mile of operating the vehicles. The following schedule presents the operating budget for the current year, which has been approved by the university. The schedule also shows actual operating costs for March of the current year compared to one-twelfth of the annual operating budget:

Gasoline Oil, minor repairs, parts Outside repairs Insurance

UNIVERSITY MOTOR POOL Budget Report for March Annual Operating Monthly Budget Budget** Tk.42,000 Tk.3,500 3,600 300 2,700 225 6,000 500

March (Over)Under Actual Budget Tk.4,300 Tk.(800) 380 (80) 50 175 525 (25) 124


Salaries and benefits 30,000 Depreciation of vehicles 26,400 Total costs Tk.110,700 Total miles 600,000 Cost per mile Tk.0.1845 Number of automobiles in use 20 ** Annual operating budget á 12 months.

2,500 2,200 Tk.9,225 50,000 Tk.0.1845 20

2,500 2,310 Tk.10,065 63,000 Tk.0.1598 21

(110) Tk.(840)

The annual operating budget was constructed on the following assumptions: (a) Twenty automobiles in the motor pool. (b) Thirty thousand miles driven per year per automobile. (c) Fifteen miles per gallon per automobile. (d) Tk.1.05 per gallon of gasoline. (e) Tk.0.006 cost per mile for oil, minor repairs, and parts. (f) Tk.135 cost per automobile per year for outside repairs. (g) Tk.300 cost per automobile per year for insurance. The supervisor of the motor pool is unhappy with the monthly report comparing budget and actual costs for March, claiming it presents and unfair picture of performance. A previous employer used flexible budgeting to compare actual costs to budgeted amounts. Required: (i) Prepare a new performance report for March showing budgeted costs, actual costs, and variances. In preparing your report, use flexible budgeting techniques to compute the monthly budget figures. (ii) What are the deficiencies in the performance report presented above? How does the report that you prepared in (i) above overcome these deficiencies? CMA Adapted – April 2011 E-16. The following particulars are available from the records of Lionel Messi and Company Limited for two periods. Period-i Period-ii Output 60,000 units 80,000 units Cost: Tk. Tk. Direct materials 1,20,000 1,60,000 Direct wages 3,00,000 4,00,000 Direct expenses 60,000 80,000 Prime cost 4,80,000 6,40,000 Overheads: Consumable materials 15,000 20,000 Shop labour 6,000 8,000 Maintenance & repairs 8,000 10,000 Inspection 1,600 1,800 Depreciation 10,000 10,000 Insurance 5,000 5,000 Salaries 6,000 6,000 Total overheads 51,600 60,800 Total factory cost 5,31,600 7,00,800 125


Total production at 100% capacity is 1,00,000 units. Prepare a flexible budget for 70% and 90% capacity. CMA Adapted – December 2010 E-17. The Eastern Computer Company is a manufacturer of Video conferencing products to meet marketing projection regularly and specialized entries are produces after an order is received. Maintaining the video-conferencing equipment is an important area of customer satisfaction. With the recent downturn in the computer industry the video-conferencing segment has suffered leading to decline in the Eastern‟s financial performance. The following income statement shows the results for the year ending December 31, 2003. The Eastern Computer Company Income Statement For the year ended December 31, 2003 Revenues Video-conferencing equipment Maintenance contracts Less: Cost of goods sold Gross profit Less: Operating costs: Marketing Distribution Customer maintenance Administrative Total operating cost Operating income

Taka 6,000 1,800

Taka in „000‟ Taka 7,800 4,600 3,200

600 150 1,000 900 2,650 550

The controller of the company is in the process of preparing the budget for the year ended December 31, 2014. (1) Selling price of equipment is expected to increase by 10%. As the economy recovery begins the selling price of each maintenance contract is unchanged. (2) Equipment sales in units are expected to increase by 60% with a corresponding 6% growth in units of maintenance contracts. (3) The cost of each equipment sold is expected to increase by 3% to pay necessary technology and quality improvements. (4) Marketing costs are expected to increase by Tk.250,000 but the administrative costs are expected to be the same as for 2003. (5) Distribution costs vary in proportion to the number of units equipment sold. (6) Two maintenance technicians are to be added at a total cost of Tk.130,000 which covers salaries and related travel costs. The objective is to improve customer service and shorten response time. (7) There is no beginning or ending inventory of equipment. Required: Prepare a budgeted Income Statement for the ended December 31, 2004. CMA Adapted – August 2010 126


E-18. The management of the Gulshan Company wants to prepare budgets for one of its products, Dura flex for July 2010. The firm sells the product for Tk.40.00 per unit and has the following expected sales units for these months in 2010. April 5,000

May 5,400

June 5,500

July 6,000

August 7,000

September 8,000

The production process required 4 pounds of Dura-1000 and 2 pounds of flex-plus. The firm‟s policy is to maintain a minimum of 100 units of Dura flex on hand at all time. The units on hand at the end of a period, however, should not fall below 10 percent of the expected sales for the following month. All materials inventories are to be maintained at 5 percent of the production needs for the next month, but not to exceed 1,000 pounds. The firm expects all inventories at the end of June to be within the guidelines. The purchase department expects the materials to cost Tk.1.25 per pound and Tk.5.00 per pound of Dura-1000 and flex-plus respectively. The production process requires direct labor at two skill levels. Workers at the K102 level earn Tk.50.00 per hour and can process one batch of Dura flex per hour. Each batch consists of 100 units. The manufacturing of Dura flex also requires one-tenth of an hour of K 175 worker‟s time for each unit manufactured. K 175 worker‟s earn Tk.20.00 per hour. Manufactured overhead is allocated at the rate of Tk.200.00 per batch and Tk.30.00 per direct labor hour. Required: On the basis of the preceding data and projections, prepare the following budgets for July, 2010: (i) Sales budget (in taka) (ii) Production budget (in units) (iii) Production budget for August (in units) (iv) Direct materials purchased budget (in pounds) (v) Direct materials purchase budget (in taka) (vi) Direct manufacturing labor budget (in taka) CMA Adapted – December 2009

127


CHAPTER - 4 PROJECT APPRAISAL

4.1. DEFINITION OF ACTIVITY BASED COSTING Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing. 4.2. ADVANTAGES OF ACTIVITY BASED COSTING i. Improves over all processes: During the process of implementing an activity based costing method in a business, all of the processes that are used are looked at in depth. After a short period of time, a bigger picture begins to emerge of which processes are working well and which are not. ii. Waste is identified: Overhead costs often include quite a few wasteful products. All of these can be identified very simply with an ABC method of cost analysis, and then removed from the business all together, or at least managed more effectively. iii. Pricing is better organized: With ABC businesses are able to fully identify all the costs that are associated with producing a single unit of their product. Because of this new understanding, they are able to develop pricing strategies and marketing much more efficiently. iv. Can be applied to the entire business: It may seem that activity based costing is only effective and efficient for the production costs that are involved in a business, but all overhead costs can be reduced using this method. 4.3. DISADVANTAGES OF ACTIVITY BASED COSTING i. Reduction is not always possible: If the overhead costs are high for reasons such as volume, there are very limited benefits to be reaped from activity based costing. It also is not very efficient if the overhead costs of the business only represent a very small portion of the costs. ii. High implementation costs: ABC method of costs may not be best if the overhead waste is perceived to be relatively low. This is because it can be very costly to implement activity based costing into a business. iii. Time involved: There is a long time period that is involved in using an activity based costing method in a business. All of the production processes, employee actions, and aspects of the business 128


have to be examined for an extended period of time in order to gain a big view on what the issues truly are. iv. Data flaws: ABC requires many different departments and individuals to collect and input data. Even the smallest flaw in this information can damage the entire process. 4.4. DEFINITION OF TRADITIONAL COSTING Traditional costing is the allocation of factory overhead to products based on the volume of production resources consumed. Under this method, overhead is usually applied based on either the amount of direct labor hours consumed or machine hours used. 4.5. WEAKNESS OVERHEAD

OF

TRADITIONAL

COSTING

FOR

ALLOCATING

Under the traditional method of allocating factory overhead, most of the overhead costs are allocated on the basis of just one factor such as machine hours or direct labor hours. In reality there are many drivers of the factory overhead: machine setups, unique inspections, special handling, special storage, and so on. The more diversity in products or in customer demands, the bigger the problem of allocating all the costs of these various activities via only one activity such as the production machine's hours. Under the traditional method, the costs of performing all of the diverse activities will be contained in one cost pool and will be divided by the number of production machine hours. This results is one average rate that is applied to all products regardless of the number of activities and the complexity of those activities. Since the cost of many of the diverse activities do not correlate at all with the number of production machine hours, the resulting allocations are misleading. 4.6. DIFFERENCES BETWEEN TRADTIONAL COSTING

ACTIVITY

BASED

COSTING

AND

i. Traditional costing is almost obsolete whereas activity based costing is largely in use since 1981. ii. Traditional costing focuses on the structure rather than on processes whereas Activity based costing focuses on the activities or processes rather than on the structure. iii. Activity based costing provides accurate costs whereas traditional costing accumulates values arbitrarily. iv. Activity based costing is more effective and efficient for the determination of production costs than traditional costing. 4.7. IMPLICATIONS OF SWITCHING TO ACTIVITY BASED COSTING SYSTEM The use of activity based costing system has following implications: i) Pricing decisions will be improved because the price will be based on more accurate cost data. ii) Sales strategy can be based on more realistic product costs resulted unprofitable customer may be profitable. 129


iii) Costs will be more relevant and decision making can be improved. iv) Performance management can be improved due to the focus on selling the most profitable products and through the control of cost drivers. 4.8. SHORT NOTES Cost object: A cost object is a term used primarily in cost accounting to describe something to which costs are assigned. Common examples of cost objects are: product lines, geographic territories, customers, departments or anything else for which management would like to quantify cost. Cost pool: It is a collection of costs that are to be assigned to cost objects. Costs are often pooled because they have the same cost driver. An example of cost pool is all costs related to material handling in a manufacturing firm. Cost driver: A cost driver is the unit of an activity that causes the change in activity's cost. Cost driver is any factor which causes a change in the cost of an activity. Cost reduction: Cost reduction is the process used by companies to reduce their costs and increase their profits. Depending on a company's services or product, the strategies can vary. Every decision in the product development process affects cost.

130


PROBLEMS AND SOLUTIONS P-1. Nixon Company manufactures two products, Product A and Product B. Unit costs for materials and labor are given below: Particulars Product A Product B Direct Material Tk.150 Tk.200 Direct Labor 100 180 One unit of Product A requires one machine hour, Product B requires two machine hours for completion. Estimated factory overhead costs are Tk.12,00,000 to produce 20,000 units of Product A and 40,000 units of Product B. There are some complains from the customers regarding product costs. To achieve more relevant product costs the company decided to apply ABC with the following information: Activity Traceable Costs Product A Product B Machine Setups Tk.600,000 4,000 2,000 Purchase Orders 400,000 3,000 1,000 Material Receipts 200,000 500 500 Required: (a) Compute the predetermined overhead application rate. (b) Compute activity rates and overhead cost per unit of Product A and B. Solution: (a) Predetermined overhead application rate Tk.12,00,000 = {(20,000 X 1)  (40,000 X 2)} machine hour Tk.12,00,000 = (20,000  80,000) machine hour = Tk.12 per machine hour (b) Computation of activity rates: Activity Traceable cost (Tk.) Machine setups 600,000 Purchase orders 400,000 Material receipts 200,000

Total activity 6,000 4,000 1,000

Computation of overhead cost per unit of product A: Activity Activity rates Product A (Tk.) Machine setups 100 4,000 Purchase orders 100 3,000 Material receipts 200 500 Total overhead Unit produced Overhead cost per unit 131

Activity rates (Tk.) 100 100 200

Total overhead (Tk.) 400,000 300,000 100,000 Tk.800,000 20,000 Tk.40


Computation of overhead cost per unit of product B: Activity Machine setups Purchase orders Material receipts Total overhead Unit produced Overhead cost per unit

Activity rates (Tk.) 100 100 200

Product B 2,000 1,000 500

Total overhead (Tk.) 200,000 100,000 100,000 Tk.400,000 40,000 Tk.10

P-2. Delta Company produces two different products: General and Hybrid. In determining the product cost, the company allocates all overhead costs based on machine-hours. With the recent addition of a computer system, Delta Company decided to begin implementing ABC. Under this new system, the company allocates overhead costs based on activity. However, they will continue to use machine-hours as the base for allocating all remaining overhead. The company has following information regarding the above products for the current year operation: General Hybrid Total Units produced 9,400 6,600 16,000 Direct material costs (Tk.) 200,000 100,000 300,000 Direct labor cost (Tk.) 140,000 1,60,000 300,000 Machine hours 6,000 4,000 10,000 Machine set ups 4,000 2,000 6,000 Overhead cost: Machine set ups related (Tk.) 600,000 Others (Tk.) 400,000 Required: (a) Using the current system, determine the unit cost for each product. (b) Using the ABC system, determine the unit cost for each product. Solution: (a) Computation of unit cost under current system:

Direct material Direct labor Factory overhead Tk.10,00,000 General = X 6,000 10,000 hours Tk.10,00,000 Hybrid = X 4,000 10,000 hours Total cost Units produced Unit cost

General Tk. 200,000 140,000 600,000

Tk.940,000 9,400 Tk.100

Hybrid Tk. 100,000 160,000 400,000

Tk.660,000 6,600 Tk.100

132


(b) Computation of unit cost under ABC system: General Tk. 200,000 140,000

Hybrid Tk. 100,000 160,000

Machine setups Tk.600,000 General = X 4,000 6,000 Tk.600,000 Hybrid = X 2,000 6,000

400,000

200,000

Others

240,000

160,000

Direct material Direct labor Factory overhead:

Tk.400,000 General = X 6,000 10,000 Tk.400,000 Hybrid = X 4,000 10,000 Total cost Units produced Unit cost

Tk.980,000 9,400 Tk.104.26

Tk.620,000 6,600 Tk.93.94

P-3. Raising Company produces its products using traditional two-stage cost allocation system. In the first stage, all factory overhead costs are assigned to two production departments, A and B, based on machine-hours. In the second stage, direct labour hours are used to allocate overhead to individual products, X and Y. During 2017, the Company has a total factory overhead cost of Tk.200,000. Machine hours in production departments A and B were 12,000 and 8,000 hours respectively. Labour hours in production departments A and B were 6,000 and 4,000 respectively. The following information relates to products X and Y for the month of January 2017: X 500 Tk.400 Tk.200 2 4

Units produced Material cost per unit Labour cost per unit Labour hours in A per unit Labour hours in B per unit

Y 1,000 Tk.600 Tk.300 3 6

Company is considering implementing an activity-based costing system. Its management accountant has collected the following information for activity cost analysis. Activity Material movement Machine setup

133

Cost driver No. of production runs No. of setup

OH Rate (Tk.) 50 25

X 1,000 6,000

Y 3,000 2,000


Calculate the unit cost for each of the two products: (a) Under existing traditional system. (b) If the proposed ABC system is adopted. Solution: Allocation of overhead to the department A and B:

200,000 X 12,000 (12,000  8,000) = 120,000

A=

200,000 X 8,000 (12,000  8,000) = 80,000

B=

(a) Calculation of unit cost under traditional system:

Direct material Direct labour Factory overhead 120,000 X=( X 2) + ( 6,000 120,000 Y=( X 3) + ( 6,000

X (Tk.) 400 200 120

Y (Tk.) 600 300 180

80,000 X 4) 4,000 80,000 X 6) 4,000 720

1,080

(b) Calculation of unit cost under ABC system:

Direct material Direct labour Factory overhead: Material movement 50X 1,000 X= 500 50X 3,000 Y= 1,000 Machine setup 25X 6,000 X= 500 25X 2,000 Y= 1,000

X (Tk.) 400 200

Y (Tk.) 600 300

100

150

300

50

1,000

1,100

134


P-4. XYZ Company manufactures two products, Product A and Product B. Manufacturing costs for the products are given below: Particulars Product A Product B Total Direct Material Tk.100,000 Tk.260,000 Tk.360,000 Direct Labor 60,000 80,000 140,000 Factory overhead 300,000 Product A requires 1,000 labour hours and product B requires 2,000 labour hours to be manufactured. The company has only fixed labor hours and runs at capacity. Recently, the company introduces Activity Based Costing (ABC) system to manufacture its products and given the following information: Activity Identifiable Total Product A Product B Costs Activity Machine Setups Tk.240,000 2,400 1,000 1,400 Purchase Orders 100,000 1,000 400 600 Material Receipts 200,000 2,000 1,200 800 Required: (a) Compute total costs of Product A and B under traditional costing. (b) Compute total costs of Product A and B under ABC. (c) Reconcile the total costs reported for Product A by the two costing systems. Solution: (a) Computation of total costs under traditional costing:

Direct material Direct labor Factory overhead Tk.300,000 A= X 1,000 3,000 hours Tk.300,000 B= X 2,000 3,000 hours Total cost

Product A Tk. 100,000 60,000 100,000

Tk.260.000

Product B Tk. 260,000 80,000 200,000

Tk.540.000

(b) Computation of total costs under ABC:

Direct material Direct labor Factory overhead: Machine setups Tk.240,000 A= X 1,000 2,400 135

Product A Tk. 100,000 60,000

Product B Tk. 260,000 80,000

100,000

140,000


B=

Tk.240,000 X 1,400 2,400

Purchase orders Tk.100,000 A= X 400 1,000 Tk.100,000 B= X 600 1,000 Material receipts Tk.200,000 A= X 1,200 2,000 Tk.200,000 B= X 800 2,000 Total cost

40,000

60,000

120,000

80,000

420,000

620,000

(c) Reconciliation of the total costs of Product A: Particulars Direct material Direct labor Factory overhead Total

Under traditional costing 100,000 60,000 100,000 260,000

Under ABC 100,000 60,000 260,000 420,000

Changes 0 0 (160,000) (160,000)

P-5. Sevenâ€&#x;s Cookhouse is a popular restaurant located at Lake Union in Seattle. The owner of the restaurant has been trying to better understand costs at the restaurant and has hired a student intern to conduct an activity-based costing study. The intern, in consultation with the owner, identified three major activities. She then completed the firststage allocations of costs to the activity cost pools, using data from last monthâ€&#x;s operations. The results appear below: Activity Cost Pool Serving a party of diners Serving a diner Serving a drink

Activity Measure Number of parties served Number of diners served Number of drinks ordered

Total Cost Tk.12,000 Tk.90,000 Tk.26,000

Total Activity 5,000 parties 12,000 diners 10,000 drinks

The above costs include all of the costs of the restaurant except for organization-sustaining costs such as rent, property taxes, and top-management salaries. A group of diners who ask to sit at the same table are counted as a party. Some costs, such as the costs of cleaning linen, are the same whether one person is at a table or the table is full. Other costs, such as washing dishes, depend on the number of diners served. Prior to the activity-based costing study, the owner knew very little about the costs of the restaurant. He knew the total cost for the month (including organizing-sustaining costs) was Tk.180,000 and that 12,000 diners had been served. Therefore the average cost per diner was Tk.15.

136


Required: (a) According to the activity-based costing system, what is the total cost of serving each of the following parties of diners? i. A party of four diners who order three drinks in total. ii. A party of two diners who do not order any drinks. iii. A lone diner who orders two drinks. (b) Convert the total costs you computed in (a) above to cost per diner. In other words, what is the average cost per diner for serving each of the following parties of diners? i. A party of four diners who order three drinks in total. ii. A party of two diners who do not order any drinks. iii. A lone diner who orders two drinks. (c) Why do the costs per diner for the three different parties differ from each other and from the overall average cost of Tk.15.00 per diner? Solution: (a) Determination of activity rates: Activity cost pool Serving a party of diners Serving a diner Serving a drink

Total cost (Tk.) 12,000 90,000 26,000

Total activity 5,000 parties 12,000 diners 10,000 drinks

Activity rate (Tk.) 2.40 per party 7.50 per diner 2.60 per drink

i. A party of four diners who order three drinks in total: Activity cost pool Serving a party of diners Serving a diner Serving a drink

Activity rate (Tk.) 2.40 per party 7.50 per diner 2.60 per drink

Activity 1 party 4 diners 3 drinks Total

ABC cost (Tk.) 2.40 30.00 7.80 40.20

Activity 1 party 4 diners 0 drink Total

ABC cost (Tk.) 2.40 15.00 0 17.40

Activity 1 party 1 diner 2 drinks Total

ABC cost (Tk.) 2.40 7.50 5.20 15.10

ii. A party of two diners who do not order any drinks: Activity cost pool Serving a party of diners Serving a diner Serving a drink

Activity rate (Tk.) 2.40 per party 7.50 per diner 2.60 per drink

iii. A lone diner who orders two drinks: Activity cost pool Serving a party of diners Serving a diner Serving a drink

137

Activity rate (Tk.) 2.40 per party 7.50 per diner 2.60 per drink


(b) The average cost per diner for each party can be computed by dividing the total cost of the party by the number of diners in the party as follows: Tk.40.20 i. = Tk.10.05 per diner 4 diners Tk.17.40 ii. = Tk.8.70 per diner 2 diners Tk.15.10 iii. = Tk.15.10 per diner 1 diner (c) The average cost per diner differs from party to party under the activity-based costing system for two reasons. First, the Tk.2.40 cost of serving a party does not depend upon the number of diners in the party. Therefore, the average cost per diner of this activity decreases as the number of diners in the party increases. With only one diner, the cost is Tk.2.40. With two diners, the average cost per diner is cut in half to Tk.1.20. With six diners, the average cost per diner would be only Tk.0.40, and so on. Second, the average cost per diner differs also because of the differences in the number of drinks ordered by the diners. If a party does not order any drink, as was the case with the party of two, no costs of serving drink as assigned to the party. The average cost per diner differs from the overall average cost of Tk.15 per diner for several reasons. First, the average cost of Tk.15 per diner includes organization-sustaining costs that are excluded from the computation in the activity-based costing system. Second, the Tk.15 per diner figures does not recognize that some diners order more drinks that others nor does it recognizes that there are some economics of scale in serving large parties. The batch-level costs of serving a party can be spread over more diners if the party is large. We should note that, the activity-based costing system itself does not recognize all of the differences in diner‟s demands on resources. For example, the costs of preparing the various meals on the menu surely differ. It may or may not be worth the effort to build a more detail activity-based costing system that would take such nuances into account. P-6. Shaw Wallace makes two types of soft drinks: a regular soft drink and a premium soft drink. Shaw Wallace distributes the regular soft drink and the premium soft drink through different distribution channels. It distributes 2,40,000 cases of regular soft drink through 10 general distributors and 1,60,000 cases of the premium soft drink through 30 specialty distributors. Shaw Wallace incurs Tk.42,60,000 in distribution costs. Under its existing costing system, Shaw Wallace allocates distribution costs to products on the basis of cases shipped. To understand better the demands on its resources in the distribution area, Shaw Wallace identifies three activities and related activity costs. (a) Promotional costs – Shaw Wallace estimates it incurs Tk.16,000 per distributor. (b) Order handling costs – Shaw Wallace estimates costs of Tk.600 pertaining to each order. Shaw Wallace records show that distributors of regular soft drink place an average of 10 orders per year, whereas distributors of premium soft drink place an average of 20 orders per year. (c) Delivery costs – Tk.8 per case. 138


Required: (i) Using Shaw Wallace existing costing system, calculate the total distribution costs and distribution cost per case for the regular soft drink and the premium soft drink. (ii) Using Shaw Wallace activity-based costing system, calculate the total distribution costs and distribution cost per case for the regular soft drink and the premium soft drink. (iii) Explain the cost differences and the accuracy of the product costs calculated using the existing costing system and the ABC system. How might Shaw Wallace management use the information from the ABC system to manage its business better? Solution: (i) Distribution cost under existing system:

Distribution costs k.10.65 X 2,40,000 cases Tk.10.65 X 1,60,000 cases

Regular soft drink Total Per case (Tk.) (Tk.) 25,50,000 10.65

Premium soft drink Total Per case (Tk.) (Tk.) 17,40,000 10.65

Here,

Total distributi on cos ts Total case of premium and regular wine shipped Tk.42,60,000 = 2,40,000  1,60,000 = Tk.10.65 per case

Distribution cost per case =

(ii) Distribution costs under activity-based costing system:

Promotional costs Tk.16,000 X 10 distributors Tk.16,000 X 30 distributors Order handling costs Tk.600 X 10 orders X 10 distributors Tk.600 X 20 orders X 30 distributors Delivery costs Tk.8 X 2,40,000 cases Tk.8 X 1,60,000 cases Total costs

Regular soft drink Total (Tk.) Per case (Tk.) 1,60,000 0.67

Premium soft drink Total Per case (Tk.) (Tk.) 17,40,000 3.00

60,000

0.25

3,60,000

2.25

19,20,000

8.00

12,80,000

8.00

21,40,000

8.92

21,20,000

13.25

(iii) The existing costing system uses cases shipped as the only cost allocation base for distribution costs. As a result, the distribution cost per case is the same for premium and regular soft drinks (Tk.10.65). In fact, premium soft drink uses distribution resources more intensively than regular soft drink: - Shaw Wallace spends Tk.16,000 on promotional costs at each distributor independence of cases sold. Premium soft drink distributors sell fewer cases a year 139


-

than regular soft drink distributors. As a result the promotional cost per case of soft drink sold higher for premium soft drink than for regular soft drink. Shaw Wallace‟s cost per order is Tk.600 regardless of the number of cases sold in each order. Because premium soft drink distributors order fewer cases per order, the ordering costs per case are higher for premium soft drinks than for regular soft drinks.

The existing costing system, under-costs distribution costs per case for premium soft drink and over-costs distribution costs per case for regular soft drink. P-7. Bangla Steel Ltd. Manufactures two types of Spare Parts i.e. Bobbin and Paddle Wheel and applies/ absorbs overheads on the basis of direct-labor hours. The budgeted overheads and direct labor hours for the month of February, 2018 are BDT.12,42,500 and 20,000 hours respectively. Other information concerning Company‟s products is as follows: Bobbin Paddle Wheel Budgeted production volume (Units) 2,500 3,125 Direct materials cost per unit (BDT) 300 450 Direct labor cost (BDT) 450 600 (3H X BDT.150) (4H X BDT.150) Bangla Steel Ltd.‟s overheads of BDT.12,42,500 can be identified with the following three major activities: Order Processing (BDT.2,10,000), Machine Processing (BDT.8,75,000), and Product Inspection (BDT.1,57,500). These activities are driven by number of orders processed, machine hours worked, and inspection hours, respectively. The data relevant to these activities is as follows: Product Orders Processed Machine Hours Worked Inspection Hours Bobbin 350 23,000 4,000 Paddle Wheel 250 27,000 11,000 Total 600 50,000 15,000 Required: (a) Assuming use of direct-labor hours to absorb/apply to overheads to production, compute the unit manufacturing cost of Bobbin and Paddle Wheel, if the budgeted manufacturing volume is attained. (b) Assuming use of activity-based costing, compute the unit manufacturing costs of Bobbin and Paddle Wheel, if the budgeted manufacturing volume is achieved. (c) Bangla Steel Ltd.‟s selling prices are based heavily on cost. By using direct-labor hours as an application base, calculate the amount of cost distortion (under-costed or overcosted) for each spare parts. Solution: (a) Computation of unit manufacturing costs:

Direct material Direct labor Overheads (3H X Tk.62.125), (4H X Tk.62.125) Unit manufacturing cost

Bobbin BDT 300 450 186.38 936.38

Paddle Wheel BDT 450 600 248.50 1,298.50 140


Here,

BDT .12,42,500 20,000 hours = BDT.62.125 per hour

Predetermined overhead rate =

(b) Estimation of cost drivers: Activity Order processing Machine processing Product inspection

Overhead costs BDT 2,10,000 8,75,000 1,57,500

Cost-driver level Cost-driver rate BDT 600 orders processed 350 50,000 machine hours 17.50 15,000 inspection hours 10.50

Computation of unit manufacturing costs using activity-based costing:

Direct material Direct labor Overheads: Order processing Machine processing Product inspection Unit manufacturing cost

Bobbin BDT 300 450

Paddle Wheel BDT 450 600

49 161 16.80 976.80

28 151.20 36.96 1,266.16

(c) Determination of cost distortion: Unit manufacturing cost Using direct labor hours as application base Using activity based costing Cost distortion

Bobbin BDT 936.38 976.80 (40.42)

Paddle Wheel BDT 1,298.50 1,266.16 32.34

Low volume product Bobbin is under-costed and high volume product Paddle Wheel is over-costed using direct labor hours as a basis for overheads absorption. It is due to the limitation of traditional costing system. P-8. Eric Inc. manufactures two model of high pressure steam valves, the XR7 model and ZD5 model. Data regarding the two products follows: Product XR7 ZD5

Direct labor hour 0.2 DLHs per unit 0.4 DLHs per unit

Annual production 20,000 units 40,000 units

Total direct labor hours 4,000 DLHs 16,000 DLHs 20,000 DLHs

Additional information about the company follows: (a) Direct material requires for XR7 Tk.35 and for ZD5 Tk.20. (b) Direct labor rate per hour Tk.20. (c) Manufacturing overhead per year Tk.1,480,000 and company uses DLH as the base for applying manufacturing overhead costs. 141


(d) Product XR7 is more complex to produce that ZD5 and requires the use of special milling machine. (f) Because of the special work required in (d) above, the company is considering the use of Activity Based Costing to apply overhead cost to products. Three activity cost pools have been identified data concerning these activity pools appear below: Total activity Activity cost pools Activity measure Total cost XR7 ZD5 Total Machine setups No. of setups Tk.180,000 150 100 250 Special milling Machine hour Tk.300,000 1,000 0 1,000 General factory Direct labor hours Tk.1,000,000 4,000 16,000 20,000 Required: (a) Assume that the company continues to use direct labor hours as the base for applying overhead cost to products: (i) Compute predetermined overhead rate; (ii) Determine the unit product cost of each product. (b) Assume the company decides to use activity based costing to apply overhead cost to products: (i) Compute the activity rate for each activity pool. Also compute the amount of overhead cost that would be applied to each product. (ii) Determine the cost unit product cost of each product. (c) Explain why overhead cost shifted from the high volume to the low volume product under activity based costing. Solution: (a)

Total overhead cos ts Total direct labor hours Tk.14,80,000 = 20,000 DLH = Tk.74 per DLH

(i) Predetermined overhead rate =

(ii) Determination of unit product cost:

Direct material Direct labor 0.2 X Tk.20 0.4 X Tk.20 Manufacturing overhead 0.2 X Tk.74 0.4 X Tk.74 Unit product cost

XR 7 (Tk.) 35 4

ZD 5 (Tk.) 20 8

14.80

29.60

53.80

57.60

142


(b) (i) Computation of activity rates: Activity cost pool Machine setups Special milling General factory

Overhead costs Tk. 1,80,000 3,00,000 10,00,000

Total activity 250 1,000 20,000

Activity rates Tk. 720 300 50

Computation of activity rates for each activity pool: Activity cost pool Machine setups Special milling General factory Total overhead costs Production units Overhead cost per unit

XR 7 Tk. 1,08,000 3,00,000 2,00,000 6,08,000 20,000 30.40

ZD 5 Tk. 72,000 0 8,00,000 8,72,000 40,000 21.80

(ii) Determination of unit product cost:

Direct material Direct labor Manufacturing overhead Unit product cost

XR 7 (Tk.) 35 4 30.40 69.40

ZD 5 (Tk.) 20 8 21.80 49.80

(c) Overhead cost shifted from high volume product (ZD5) to low volume product (XR7) due to the following reasons: - XR7 needs more machine setup costs as well as special milling costs resulting in more overhead costs. - Under activity based costing system applied overhead rate is more in XR7 than that of ZD5 unlike that of traditional system. - Activity cost has been considered rather than volume of production. P-9. The Atlas Corporation has a machining facility specializing in jobs for the aircraft components market. Atlasâ€&#x;s previous simple job-costing system had two direct-cost categories (direct materials and direct manufacturing labor) and a single indirect-cost pool (manufacturing overhead, allocated using direct manufacturing labor-hours). The indirect cost-allocation rate of the simple system for 2017 would have been Tk.115 per direct manufacturing labor-hour. Recently a team with members from product design, manufacturing, and accounting used an ABC approach to refine its job-costing system. The two direct-cost categories were retained. The team decided to replace the single indirect-cost pool with five indirect-cost pools. The cost pools represent five activity areas at the plant, each with its own supervisor and budget responsibility. Pertinent data are as follows: 143


Activity Area Material Handling Lathe Work Milling Grinding Testing

Cost Collection Base Parts Lathe Unit Machine-hour Parts Units Tested

Cost Allocation Rate Tk.0.40 0.20 20.00 0.80 15.00

Information-gathering technology has advanced to the point at which the data necessary for budgeting in these five activity areas are collected automatically. Two representative jobs processed under the ABC system at the plant in the most recent period had the following characteristics: Particulars Direct material cost per job Direct manufacturing labor cost per job Number of direct manufacturing labor-hours per job Parts per job Lathe turns per job Machine-hours per job Units per job (all units are tested)

Job 410 Tk.9,700 Tk.750 25 500 20,000 150 10

Job 411 Tk.59,900 Tk.11,250 375 2,000 59,250 1,050 200

Required: (a) Compute the manufacturing cost per unit for each job under the previous simple job costing system. (b) Compute the manufacturing cost per unit for each job under the previous activity-based costing system. (c) Compute the per-unit cost figures for Jobs 410 and 411 computed in requirements (i) and (b). Why do the simple and activity-based costing systems differ in the manufacturing cost per unit for each job? Why might these differences be important to Atlas Corporation? Solution: (a) Computation of manufacturing cost under simple job costing system:

Direct material Direct manufacturing labor Tk.30 X 25, Tk.30 X 375 Indirect material cost Tk.115 X 25, Tk.115 X 375 Total manufacturing cost Divided by number of units Manufacturing cost per unit

Job 410 Tk. 9,700 750

Job 411 Tk. 59,900 11,250

2,875

43,125

13,325 10 1,332.500

114,275 200 571.375

144


(b) Computation of manufacturing cost under activity-based costing system:

Direct material Direct manufacturing labor Tk.30 X 25, Tk.30 X 375 Indirect material cost: Material handling Tk.0.40 X 500, Tk.0.40 X 2,000 Lathe work Tk.0.20 X 20,000, Tk.0.20 X 59,250 Milling Tk.20 X 150, Tk.20 X 1,050 Grinding Tk.0.80 X 500, Tk.0.80 X 2,000 Testing Tk.15 X 10, Tk.15 X 200 Total manufacturing cost Divided by number of units Manufacturing cost per unit

Job 410 Tk. 9,700 750

Job 411 Tk.

200

800

4,000

11,850

3,000

21,000

400

1,600

150

3,000

18,200 10 1,820.00

109,400 200 547.00

Job 410 Tk. 1,332.500 1,820.00

Job 411 Tk. 571.375 547.00

11,250

(c) Per-unit cost figures:

Cost per unit under simple job costing system Cost per unit under activity-based costing system

Job 410 has an increase in reported unit cost of 36.6% [(Tk.1,820 – Tk.1,332.50) ÷ Tk.1,332.50], while Job 411 has a decrease in reported unit cost of 4.3% [(Tk.547 – Tk.571.375) ÷ Tk.571.375]. A common finding when activity-based costing is implemented is that low-volume products have increases in their reported costs while high-volume products have decreases in their reported cost. This result is also found in requirements (a) and (b) of this problem. Costs such as material handling costs vary with the number of parts handled (a function of batches and complexity of products) rather than with direct manufacturing labor hours, an output unit level cost driver, which was the only cost driver in the previous job costing system. The product cost figures computed in requirements (a) and (b) differ because -

the job order differ in the way they use each of five activity areas, and the activity areas differ in their indirect cost allocation bases (specifically, each area does not use the direct manufacturing labor hours indirect cost allocation base).

The following table documents how the two jobs differ in the way they use each of the five activity areas included in indirect manufacturing costs:

145


Activity area Material handling Lathe work Milling Grinding Testing

Usage activity area cost drivers as application base Job 410 Job 411 20.00% 80.00% 25.20 74.80 12.50 87.50 20.00 80.00 4.80 95.20

Usage direct manufacturing labor hour as application base Job 410 Job 411 6.25% 93.75% 6.25 93.75 6.25 93.75 6.25 93.75 6.25 93.75

The difference in product cost figures might be important to Atlas Corporation for product pricing and product emphasis decisions. The activity-based accounting system indicates that Job 410 is being under-costed while Job 411 is being over-costed. Atlas Corporation may erroneously push Job 4100 and deemphasize Job 411. Moreover, by its actions, Atlas Corporation may encourage a competitor to enter the market for Job 411 and take market share away from it. P-10. Rifat Leather Ltd. manufactures four products – namely A, B, C and D – using the same plant and processes. The following information relates to a production period: Product A B C D

Volume 500 5,000 600 7,000

Material cost per unit Tk.50 50 160 170

Direct labor per unit ½ hour ½ hour 2 hours 1½ hours

Machine time per unit ¼ hour ¼ hour 1 hour 1½ hours

Labor cost per unit Tk.30 30 120 90

Total production overheads recorded by the cost accounting system are analyzed under the following headings: Factory overhead application to machine-oriented activity is Tk.37,424. Set-up costs are Tk.4,355. Cost of ordering materials is Tk.1,920. Handling materials is Tk.7,580. Administration for space parts is Tk.8,600. Investigation into the production overhead activities for the period reveals the following totals: Product Number of Number of Number of times Number of set-ups materials orders materials was handled spares parts A 1 1 2 2 B 5 4 11 5 C 2 1 3 1 D 9 4 11 4 Required: (a) Determine overhead costs absorption rate for each products using traditional method (using machine hour). (b) Assume that the company has decided to use activity-based costing to apply manufacturing overhead cost to products. (i) Compute an overhead cost per unit of each product. (ii) Compute the unit product cost of each product. 146


Solution: (a) Determination of overhead cost absorption rate using traditional method: Tk. 37,424 4,345 1,920 7,580 8,600 59,869

Factory overhead to Machine oriented activity Setup costs Cost of ordering materials Handling materials Administration for spare parts Total overheads Total machine hours: For A (500 X ¼) For B (5,000 X ¼) For C (600 X 1) For D (700 X 1 ½) Total machine hours

125 machine 1,250 machine hours 600 machine hours 10,500 machine hours 12,475 machine hours

Tk.59,869 12,475 machine hours = Tk.4.80 per machine hour

Overhead cost absorption rate = (b)

(i) Determination of overhead cost absorption rate using activity-based costing method:

Tk.37,424 125  1,250  600  10,500 = Tk.3

Machine-oriented =

Tk.4,355 1 5  2  9 = Tk.256

Set-up costs =

Tk.1,920 1 4 1 4 = Tk.192

Ordering materials =

Tk.7,580 2  11  2  11 = Tk.281

Handling materials =

Tk.8,600 2  5 1 4 = Tk.717

Spare parts =

147


Activities Machine oriented Set-up cost Ordering materials Handling materials Spare parts Total No. of units Overhead cost per unit

A Tk. 375 256 192 562 1,434 2,819 500 5.64

B Tk. 3,750 1,280 768 3,091 3,585 12,474 5,000 2.50

C Tk. 1,800 512 192 843 717 4,064 600 6.77

D Tk. 31,500 2,304 768 3,091 2,868 40,531 7,000 5.79

A Tk. 50.00 30.00 5.64 85.64

B Tk. 50.00 30.00 2.50 82.50

C Tk. 160.00 120.00 6.77 286.77

D Tk. 170.00 90.00 5.79 265.79

(ii) Computation of unit product cost:

Materials cost Direct labor cost Overhead cost Unit product cost

P-11. Family Bazaar (FB) operates their business at capacity and decides to apply Activity Based Costing analysis to three product lines: baked item, milk and fruit juice and frozen foods. It identifies four activities and their activity cost rates are given below: Ordering Delivery and receipt of merchandise Shelf-stocking Customer support and assistance

Tk.1,000 per purchase order Tk.800 per delivery Tk.200 per hour Tk.2.00 per item sold

The revenue, cost of goods sold, store support costs, and activity usage of the three product lines are: Particulars Baked item Milk and fruit juice Frozen foods Financial data – 2017 Sales Tk.5,70,000 Tk.6,30,000 Tk.5,20,000 Cost of goods sold Tk.3,80,000 Tk.4,70,000 Tk.3,50,000 Store support costs Tk.1,14,000 Tk,1,41,000 Tk.1,05,000 Activity usage: Delivery (purchase ordering) 30 25 13 Delivery (Deliveries) 98 36 28 Shelf-stocking (Hours) 183 166 24 Customer support (item sold) 15,500 20,500 7,900 Under its simple costing system FB allocated support costs to products at the rate of 30% of cost of goods sold. Required: (a) Prepare income statement for FB using simple costing system. (b) Prepare income statement for FB using ABC system. (c) Ranking the product in terms of relative profitability in both systems. 148


Solution: (a)

Particulars

Family Bazaar Income Statement (Using Simple Costing System) Baked item Milk and Tk. fruit juice Tk. 570,000 630,000

Sales Cost: Cost of goods sold Store support (30% of COGS) Total cost Operating income Operating income รท Revenues

380,000 114,000 494,000 76,000 13.33%

470,000 141,000 611,000 19,000 12.50%

Frozen foods Tk. 520,000

Total Tk. 1,720,000

350,000 105,000 455,000 65,000 3.02%

1,200,000 360,000 1,560,000 160,000

Frozen foods Tk. 520,000

Total Tk. 1,720,000

(b) Family Bazaar Income Statement (Using Activity Based Costing System) Particulars Baked item Milk and Tk. fruit juice Tk. 570,000 630,000

Sales Cost: Cost of goods sold Ordering (1,000 X 30, 25, 13) Delivery (800 X 98, 36, 28) Self-stocking (200X183,166,24) Customer support (2 X 15500, 20500, 7900) Total cost Operating income Operating income รท Revenues

380,000 30,000 78,400 36,600 31,000

470,000 25,000 28,800 33,200 41,000

350,000 13,000 22,400 4,800 15,800

1,200,000 68,000 129,600 74,600 87,800

556,000 14,000 2.46%

598,000 32,000 5.08%

406,000 114,000 21.92%

1,560,000 160,000

(c) Under Simple Costing System Under Activity Based Costing System Baked goods 13.33% Baked goods 21.92% Frozen products 12.50% Frozen products 5.08% Milk & Fruit Juice 3.02% Milk & Fruit Juice 2.46% P-12. Hygiene Limited has supplied the following data from its activity based costing system: Assembling Processing Supporting units orders customers Total Overhead costs (Tk.) 50,000 150,000 200,000 400,000

149


Activity Cost Pool Assembling units Processing orders Supporting customers

Activity Measures No. of units No. of orders No. of customers

Total Activity 5,000 units 1,500 orders 800 customers

During the year, Hygiene Limited completed 10 orders for a customer Mr. X. Data relating these orders are given below: Units ordered Selling price Direct material Direct labour

40 units Tk.500 per unit Tk.200 per unit Tk.100 per unit

Required: (a) Compute the activity rates for activity costs pool. (b) Show overhead costs of these 40 units and 10 orders. (c) What are the product margin for the order and the customer margin for Mr. X? Solution: (a) Computation of activity rates: Activity cost pool Assembling units Processing orders Supporting customers

Overhead costs (Tk.) 50,000 150,000 200,000

Total activity 5,000 units 1,500 orders 800 customers

Activity rates (Tk.) 10 per unit 100 per order 250 per customer

(b) Computation of overhead costs for the orders: Activity cost pool Assembling units Processing orders Supporting customers Total overhead costs

Activity rates (Tk.) 10 per unit 100 per order 250 per customer

Activity 40 units 10 orders N/A

ABC Costs (Tk.) 400 1,000 N/A 1,400

(c) Sales Less. Costs: Direct material (40XTk.200) Direct labour (40XTk.100) Overhead Product margin Less. Supporting customers overhead (1XTk.250) Customer margin

Tk.20,000 Tk.8,000 4,000 1,400

(Tk.13,400) Tk.6,600 (Tk.250) Tk.6,350

150


P-13. Foam Products Inc. makes foam seat cushions for the automotive and aerospace industries. The companyâ€&#x;s activity-based costing system has four activity cost pools, which are listed below: ACTIVITY COST POOL Volume Batch processing Order processing Customer service

ACTIIVITY MEASURE Number of direct labor hours Number of batches Number of order Number of customers

The activity rates for the cost pools have been completed as follows:

Volume in Tk. Production overhead: Indirect labor Factory equipment depreciation Factory administration General selling and administrative overhead: Wages and salaries Depreciation Marketing expenses Total

Activity rates Batch Order processing processing in in Tk. Tk.

Customer service in Tk.

0.60 4.00

60.00 17.00

20.00 0.00

0.00 0.00

0.10

7.00

25.00

150.00

0.40 0.00 0.45 5.55

20.00 3.00 0.00 107.00

160.00 10.00 60.00 275.00

1,600.000 38.00 675.00 2,463.00

The company just completed a single order form Interstate Trucking for 1,000 custom seat cushions. The order was produced in two batches. Each seat cushion required 0.25 direct labor hours. The selling price was Tk.25 per unit, the direct material cost was Tk.9.00 per unit, and the direct labor cost was Tk.6.50 per unit. This was Interstate Trucking only order during the year. Required: (a) Prepare a report showing the product margin for this from an activity viewpoint. At this point, ignore the customer service costs. (b) Prepare a report showing the customer margin on sale to Interstate Trucking from an activity viewpoint. Solution: (a) The order requires 250 direct labor hours (1,000 units @ 0.25 DLHs per unit) and is run in two batches. Therefore, the overhead cost of the order according to the activity based costing system would be completed as follows:

151


Activity

Volume

Production overhead: Indirect labor (250 DLHs X Tk.0.60) Factory equipment depreciation Factory administration General selling and administrative overhead: Wages and salaries Depreciation Marketing expenses Total

Batch Order Customer processing processing service 250 DLHs 2 batches 1 order Not Total (in Tk.) (in Tk.) (in Tk.) applicable (in Tk.) (in Tk.) 150 120 20 0 290 1,000

34

0

0

1,034

25

14

25

0

64

100 0 113 1,388

40 6 0 214

160 10 60 275

0 0 0 0

300 16 173 1,877

The product margin on the order can be completed as follows: Sales (1,000 units @ Tk.25) Less. Cost: Direct material (1,000 units @ Tk.9) Direct labor (1,000 units @ Tk.6.5) Volume related overhead Batch processing related overhead Order processing related overhead

Tk.25,000 Tk.9,000 6,500 1,388 214 275 17,377 7,623

Product margin

(b) The customer margin for sales to Interstate Trucking is computed as follows: Product margin Less. Customer service overhead (1 customer @ Tk.2,463) Customer margin

Tk.7,623 2,463 5,160

Contact us to collect exercises solution. Helpline: 01711137039

152


EXERCISES E-1. Venus Private Hospital is a well-known and highly reputable provider of a range of orthopedic surgeries to local patients. The hospital has been in operation for eight years and during that time has streamlined all of its services and most of its administrative functions. The hospital accountant is keen to ensure best practice in the finance function, particularly in costing the various surgeries that are conducted and is considering the introduction of activity based costing (ABC). Venus currently applies a traditional approach to costing surgeries by attributing direct costs as far is possible and allocating hospital overheads based on the patientâ€&#x;s average length of stay (AIOS) in the hospital. Total hospital overheads for the year are budgeted at Tk.4,801,226 and the total budgeted AIOS for all patients for the year is 23,375 days. To facilitate the introduction of ABC the hospital accountant has analyses all of the overheads incurred into six categories of expense and has also established the cause or driver of the expense as shown in the table below: Expense category X-ray department costs Hospital Consultant costs Operating theatre costs Physiotherapy costs Occupational therapy costs Sundry hospital costs

Cause (driver) of expense Number of X-rays provided Number of meetings with Hospital Consultant Number of hours spent in operating theatre Number of physiotherapy sessions Number of occupational therapy sessions Average length of stay in the hospital (AIOS)

Budgeted data relating to the expense categories has also been compiled by the hospital accountant and is as follows: X-ray department costs Tk.1,008,320 Hospital Consultant costs Tk.960,267 Operating theatre costs Tk.1,104,430 Physiotherapy costs Tk.624,143 Occupational therapy costs Tk.528,106 Sundry hospital costs Tk.575,960 Total X-ray provided 6,302 Total physiotherapy sessions 15,223 Total occupational therapy session 15,003 Total hours in operating theatre 9,154 Total meetings with Hospital Consultants 8,314 Average length of stay in the hospital (AIOS) 23,375 Information relating to two surgeries conducted during the year is given below:

Direct materials cost AIOS Number of X-rays Meeting with Hospital Consultant Physiotherapy Occupational therapy Theatre time 153

Ankle surgery Tk.425 3.5 days 2 2 meetings 4 sessions 3 sessions 1.25 hours

Spine surgery Tk.960 4.2 days 5 4 meetings 5 sessions 5 sessions 2 hours


Required: (a) Calculate the total cost of each of the two surgeries noted above using: (i) The costing approach currently used by Venus Private Hospital. (ii) Activity based costing. (b) Comment on your answers in (a) (i) and (ii) above. CMA Adapted – June 2017 E-2. Very recently you have been appointed as Finance Manager of a MNC “Success Ltd.”, operating in Bangladesh with the manufacturing facility. You observed that it has evaluated all its projects based on the normal return against its investment. None of this evaluation has taken consideration of the risk associated with each project. You have informed your CFO, about the matter and he asked you to come back with details analysis on the new project which is going to be undertaken in few months‟ time. You have collected the related information like the new project will be with expected life time of five years. The project will cost $40,000 including the required Plant and Machinery. The plant and machinery will have zero resale value at the end of its life time. Demand for the product which will be produced under the new project has been identified and under current situation. Success Ltd. can only sell 30,000 units each year at a competitive price of $2.50 per unit. Raw materials will be $1.10 per units and direct labour required is $0.55 per unit, while incremental fixed costs, mainly the wages of engineer and office staff, are expected to be $12,500 per year. Success Ltd. uses a discount rate of 8% for investment appraisal purposes and expects investment projects to recover their initial investment within five years. Upon further investigation it is found that there is a significant chance that the expected sales volume of 30,000 units per year will not be achieved. The sales manager of Success Ltd. suggests that sales volumes could depend on expected economic situations that could be assigned the following probabilities: Economic Situation Probability Annual sales volume (units)

Worse 0.25 26,000

Normal 0.55 30,000

Good 0.20 32,000

Required: (a) Why is it necessary to consider risk and uncertainty when making appraisal of an investment, explain? (b) How sensitive the project‟s NPV if any changes incurred on the following variables: (i) Sales Volume; (ii) Sales Price; (iii) Variable Cost; and how useful the sensitivity analysis is when evaluating a project‟s risk? (c) Calculate and comment on the Expected Value (EV) of NPV for the new project. CMA Adapted – June 2017 E-3. DELTA sells a range of garments wear like GENTS WEAR, LADIES WEAR and KIDS WEAR through a chain of its shops. The main administration functions are provided from the company‟s head office. Each shop has its own warehouse which receives goods that are delivered from a central distribution center. 154


DELTA currently measures profitability by product group for each shop using an absorption costing system. All overhead costs are charges to product groups based on sales revenue. Overhead costs account for approximately one-third of total costs and the directors are concerned about the arbitrary nature of the current method used to charge these costs to product groups. A consultant has been appointed to analyze the activities that are undertaken in the shops and to establish an activity based costing system. The consultant has identified the following data for the latest period for each of the product groups for the shops: LADIES WEAR GENTS WEAR KIDS WEAR Sales revenue Tk.4,400k Tk.3,300k Tk.1,100k Cost of sales Tk.2,800k Tk.2,300 Tk.600k Number of deliveries 104 52 26 Number of pallets per delivery 50 20 10 Number of inventory items 20,000 14,000 6,000 Number of customers 2,100k 1,050 350k Number of requisitions 522 243 135 The consultant has also obtained the following information about the support activities: Activity

Cost driver

Customer service Warehouse receiving Warehouse issuing In-store merchandising Central administration

Number of customers Number of pallets delivered Number of requisitions Number of inventory items Sales revenue

Overhead (Tk.000) 1,100 700 300 400 316

Required: (a) Calculate the total profit for each of the product groups: (i) using the current absorption costing system; (ii) using the proposed activity based costing system. (b) Explain how the information obtained from the activity based costing system might be used by the management of the company. CMA Adapted – December 2016 E-4. Bangladesh Engineering Ltd (BEL) is a prominent engine manufacturer with permanent manufacturing facilities established in Bangladesh. It produces a range of small engines used in a variety of industries in all over the world. It has decided Research and Development team within it. BEL‟s R&D team have recently developed a small engine called „BD-Magic‟, which has been designed for SME industries. The board of directors of BEL already spent BDT 15 million on market research and analysis, the findings of which indicates that a market demand exists for the BD-Magic. The director of marketing department, Mr. A. Khan has suggested that BEL should use the world class brand “Jaguar” in order to market the new product, it will help to attract more 155


customers and also faster for the BD-Magic. CFO of BEL Mr. A. Hasan has gathered relevant information and prepared the following assessment relating to the proposed production and sale of the product. Analysis shows that an amount of 5,200 units can be sold at BDT 870,000 per unit annually in all the markets. Raw and Packing material BDT 285,000 per unit, Labour at BDT 192,000 per unit will be required for the production. BEL have to pay royalty charge of BDT 48,000 per unit to the Jaguar Inc. USA, for using their brand name. Related fixed overheads for this new product are estimated at BDT 950 million per annum. These overheads cannot be avoided until the end of the year in which the BD-Magic is withdrawn for the market. At the start of the production an initial outlay of BDT 2,200 million would be required. As an incentive for establishing such an industry a government grant equal to 50% of the initial investment would be received when the investment is made. However, no tax allowances would be available on this initial investment as itâ€&#x;s a commercial product. The estimated life cycle of the BD-Magic is seven years. Applicable corporate tax at the rate of 40% per annum is payable by BEL on the profit before tax. All cash flows are stated in current prices and, with the exception of the initial investment and the government grant, will occur at the end of each year. Cost of capital is calculated @ 18.77% p.a. for BEL. Inflation rate in Bangladesh during the period is expected to be 7% in the year. Required: (a) Calculate NPV of the BD-Magic and recommended whether it should be feasible for BEL. (b) Using sensitivity analysis, estimate by what percentage each of the under-mentioned items, taken separately, would need to change before the recommendation in (a) above is changed: (i) Initial Investment; (ii) Contribution Margin. (c) Using sensitivity analysis, estimate by what percentage the life cycle of the BD-Magic would need to change before the recommendation in (a) above is changed. (d) Comment on TWO factors other than NPV that the directors of BEL should consider when deciding whether to manufacture the BD-Magic. CMA Adapted – December 2016 E-5. SONY produces three models of television for sale to the retail market. SONY currently operates a standard absorption costing system. Budgeting information is given below: Model of television Sales Direct material Direct labour Production overhead

Production/sales (number of televisions) Machine hours per television

LED Tk.000 54,000 17,600 10,700

UHD Tk.000 86,400 27,400 13,400

LED 1,000 100

CURVED Tk.000 102,000 40,200 16,600

UHD 1,200 200

Total Tk.000 242,400 85,200 40,700 69,600 46,900 CURVED 800 300

156


The production overhead cost is absorbed using a machine hour rate. SONY is considering changing to an activity based costing system. The main activities and their associated cost drivers and overhead cost have been identified as follows: Activity Machining Set up Quality inspection Stores receiving Stores issue

Cost Driver Production overhead cost Tk.000 Machine hours 13,920 Number of set up 23,920 Number of quality inspectors 14,140 Number of component deliveries 6,840 Number of issues from stores 10,780 69,600 The analysis also revealed the following information:

Budgeted production (number of televisions) Television per production run Quality inspections per production run Number of component deliveries Number of issues from stores

LED 1,000 5 10 500 4,000

UHD 1,200 4 20 600 5,000

CURVED 800 2 30 800 7,000

Required: (a) Calculate the total gross profit for each model of television: (i) Using the current absorption costing system; (ii) Using the proposed activity based costing system. (b) Explain why an activity based costing system may produce more accurate product costs than a traditional absorption costing system. (c) Explain the possible other benefits to the company of introducing an activity based costing system. You should use the figures in part (a) to illustrate your answer. CMA Adapted – June 2016 E-6. MRT is considering whether to tender for a franchise to operate a government owned rail network. Under the terms of the franchise agreement MRT would have to make a fixed annual payment to the government and would also be required to make significant investments to maintain and develop the rail networkâ€&#x;s infrastructure. MRT would be entitled to the profits from operating the rail network for the period of the franchise. The franchise is for a period of six years after which it will be put out to tender again. Passenger numbers and fares Passenger numbers in Year 1 are estimated to be 170 million and will increase at a rate of 3% per annum. Rail fares in Year 1 will be Tk.10.00 per passenger and future price increases will be restricted under the franchise agreement to the rate of inflation. MRT plans to implement the full fare increase each year of the franchise agreement. Inflation over the six year period of the franchise is expected to be 4% per annum. Capital investment MRT plans to make a total capital investment of Tk.700 million in two installments. This will involve introducing high speed trains, updating the existing train carriage and 157


improving facilities at railway stations. An investment of Tk.400 million will be made at the start of the franchise. The remaining Tk.300 million investments will be made at the beginning of Year 4. At the end of the franchise the equipment is expected to have a residual value of Tk.100 million at Year 6 prices. Both installments of the capital investment will become eligible for tax depreciation when they are incurred. There will also be a requirement for working capital of Tk.80 million at the start of the franchise period. The requirement for working capital will not be affected by inflation. Cost The estimated annual costs, at Year 1 prices, over the franchise period are as follows: Salary costs Fixed maintenance costs Payment to the government Other fixed operating costs (excluding depreciation)

Tk.400 million Tk.80 million Tk.1,000 million Tk.240 million

The annual payment to the government will remain at Year 1 prices throughout the period of the franchise. All the other costs listed above will increase at the same rate of inflation as the passenger fares. Taxation MRT‟s financial director has provided the following taxation information: • Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in the year of disposal. • Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year. • MRT has sufficient taxable profits from other parts of its business to enable the offset of any taxable losses. Other information A cost of capital of 12% per annum is used to evaluate projects of this type. Instructions: (a) Evaluate whether MRT should tender for the rail franchise. You should use net present value as the basis of your evaluation. Total revenue, total costs and tax benefits/ charges per annum should each rounded to the nearest Taka. Ignore any costs to be incurred in the tendering process. (b) Calculate the sensitivity of the decision to tender to a change in passenger numbers. (c) Explain the benefits of carrying out a sensitivity analysis before making investment decisions. You should use the figures calculated in (b) above to illustrate your answer. CMA Adapted – December 2015 E-7. Marks Distributor works as an independent wholesaler of cosmetic goods manufactured by Xenon Care and Cosmetics in Dakota. It generally sales to three different outlets; supermarket, chain store and departmental store. The latest data for the month of November 2015 of Marks is presented below:

158


Particulars Average revenue per delivery Average COGS per delivery Number of deliveries Total number of orders Average number of line items per order Total number of store deliveries Average number of cartoon shipped per store delivery Average number of hours of shelf stocking per store delivery

Supermarket Tk. 30,900 Tk. 30,000 120 140 14 120

Chain Store Tk. 10,500 Tk. 10,000 300 360 12 300

Departmental Store Tk. 1,980 Tk. 1,800 1,000 1,500 10 1,000

300

80

16

3.0

0.6

0.1

As per the statement of finance manager, Marks has five different activities in its distribution function. The activities and the cost against such activities for the concerned month is given below: Activities 1. Customer purchase order processing 2. Line- item order4ing 3. Store delivery 4. Cartoons shipped to stores 5. Shelf – stocking at customer store Total

Activity Costs (Tk.) 80,000 63,840 71,000 76,000 10,240 301,080

The finance manager has also identified five different activity drivers with the driver data but not expert enough to trace the right driver for right activity. He needs help in this regard to install an activity based costing as he believes that such a costing traces cost more accurately with the product. Driver data is presented below: Cost Driver 1. Store deliveries 2. Hours of shelf stocking 3. Cartoons shipped 4. Purchase orders by customer 5. Line items per purchase order

Base data 1,420 640 76,000 2,000 21,280

Required: (i) Identify right cost driver for each activity, (ii) Compute gross margin percentage for three different outlets and for the Marks and show operating income. Allocate all activity costs to different outlets on the basis of respective COGS. (iii) Compute the rate per unit of the cost allocation base for each of the five activity areas. (iv) Compute the operating income of each distribution outlets using the activity based costing. Do you find any differences with the results as you have computed in requirement? Comment on the result. CMA Adapted – December 2015 E-8. The following information provides details of the costs, volume and cost drivers for a particular period of ABC (Pvt.) Limited: 159


1

Production and sales (units) 2 Raw material usage (units) 3 Direct material cost 4 Direct labor hours 5 Machine hours 6 Direct labor cost 7 Number of production runs 8 Number of deliveries 9 Number of receipts (2X7)* 10 Number of production orders 11 Overhead costs: Set-up Machines Receiving Packing Engineering

Product X 30,000

Product Y 20,000

Product Z 8,000

Total

5

5

11

Tk.25 1 1/3 1 1/3 Tk.8 3

Tk.20 2 1 Tk.12 7

Tk.11 1 2 Tk.6 20

Tk.1,238,000 88,000 76,000

9 15

3 35

20 220

32 270

15

10

25

50

30

30,000 760,000 435,000 250,000 373,000 Tk. 1,848,000 * The company operates a just-in-time inventory policy, and receives each component once per production run. In the past the company has allocated overheads to productions on the basis of direct labor hours. However, the majority of overheads are more closely related to machine hours than direct labor hours. The company has recently redesigned its cost system by recovering overheads using two volume-related bases: machine hours and a materials handling overhead rate for recovering overheads of the receiving department. Both the current and the previous cost system reported low profit margins for product X, which is the company‟s highest-selling product. The management accountant has recently attended a conference on activity-based costing, and the overhead costs for the last period have been analyzed by the major activities in order to compute activity-based costs. From the above information you are required to: (a) Compute the product costs using a traditional volume-related costing system based on the assumptions that: (i) all overheads are recovered on the basis of direct labor hours (i.e. the company‟s past product costing system); (ii) The overheads of the receiving department are recovered by a materials handling overhead rate and the remaining overheads are recovered using a machine hour rate (i.e. the company‟s current costing system). (b) Compute product costs using an activity-based costing system. CMA Adapted – August 2015 160


E-9. The job costing system at Smith‟s Custom Framing has five indirect cost pools (purchasing, material handling, machine maintenance, product inspection, and packaging). The company is in the process of bidding on two jobs; Job 215, an order of 15 intricate personalized frames, and Job 325, an order of 6 standard personalized frames. The controller wants you to compare overhead allocated under the current simple job-costing system and a newly- designed activity- based job – costing system. Total budgeted costs in each indirectly cost pool and the budgeted quantity of activity driver are as follows:

Purchasing Material handling Machine maintenance Product inspection Packaging

Budgeted Overhead (Tk.) 70,000 87,500 237,300

Activity Driver Purchase orders processed Material moves Machine-hours

Budgeted Quantity of Activity Driver 20,000 5,000 10,500

18,900 Inspections 1,200 39,900 Units Produced 3,800 453,600 Information related to Job 215 and Job 325 follows. Job 215 incurs more batch-level costs because it uses more types of materials that need to be purchased, moved and inspected relative to Job 325 Job 215 Job 325 Number of Purchase orders 25 8 Number of Material moves 10 4 Machine – hours 40 60 Inspections 9 3 Units Produced 15 6 Required: 1. Compute the total overhead allocated to each job under a simple costing system, where overhead is allocated based on machine-hours. 2. Compute the total overhead allocated to each job under an activity-based costing system using the appropriate activity drivers. 3. Explain why Smith‟s Custom Framing might favor the ABC job – costing system over the simple job costing system, especially in its bidding process. CMA Adapted – April 2015 E-10. Smart Technology (ST) especially produce tab, laptop and desktop Pc. ST currently operates a standard absorption costing system. Budgeted information for the next year is given below. (Tk. in‟000) Particulars Tablets Laptop Desktop Total Sakes revenue 1,820 6,240 4,940 13,000 Direct Material 400 1,400 1,100 2,900 Direct Labor 150 600 400 1,150 Fixed production overhead 728 2,496 1,976 5,200 Gross profit:542 1,744 1,464 3,750 Fixed production overheads are currently absorbed based on a percentage of sales revenue. ST is considering changing to an Activity Based Costing System. The main activities and their associated cost drivers and overheads cost have been identified as follows: 161


Activity Cost Driver Manufacturing Scheduling Number of orders Parts handling Number of parts Assembly Assembly time Software installation & testing No of software application Packaging Number of units Total Further details have been ascertained as follows:

(Tk. in ‟000) Production overhead cost 81 1,232 2,236 1,000 651 5,200

Particulars Tab Laptop Desktop Budgeted production of next year 5000 6000 3000 Average number of units per order 10 6 4 Number of parts per Unit 20 35 25 Assembly time per unit (minutes) 20 40 30 Number of software application per unit 2 3 4 Required: Calculate the product wise total production overhead costs and gross profit using the ABC costing. CMA Adapted – December 2014 E-11. The Maori Noveltry company makes a variety of souvenirs for visitors to New Zealand. The Otago division stuffed Kiwi birds using a highly automated operation. A recently installed activity-based-costing system has four activity centers. Activity Center Cost Driver Cost per driver unit Materials receiving and handling Kilograms of materials Tk.1.2 per kg Production set-up Number of set-ups Tk.60 per set-up Cutting, sewing and assembly Number of units Tk.40 per unit Packing and shipping Number of orders Tk.10 per order Two products are called “Standard Kiwi” and “Giant Kiwi”. They require 0.2 kg and 0.4 kg of materials, respectively, at a material cost of Tk.5.3 per kg for standard kiwi and Tk.8.2 per kg for giant kiwi. One computer-controlled assembly line makes all products. When a production run of a different product is started, a set-up procedure is required to reprogram the computers and make other changes in the process. Normally, 600 standard kiwis are produced per set-up, but only 240 gaint kiwis are produced per set-up. products are packed and shipped separately, so a request from a customer for, say, three different products is considered as three different orders. The Auckland Zoo Gift Shop just placed an order for 100 standard kiwi and 50 gaint kiwis. Required: i. Compute the cost of products shipped to Auckland Zoo Gift Shop. ii. Suppose the products made for the Auckland Zoo Gift Shop required “AZ” to be printed on each kiwi. Because of the automated process, printing the initials takes no extra time or material, but it requires a special production set-up for each product. Compute the cost of products shipped to Auckland Zoo Gift Shop. iii. Explain how the activity-based-costing system helps Maori Noveltry to measure costs of individual products or orders better than a traditional system that allocates all nonmaterial costs based on labor hour. CMA Adapted – April 2014 162


E-12. Advance Products Corporation has supplied the following data from its activity based costing system: Overhead Costs Wages and salaries Other overhead costs Total overhead costs Advance Cost Pool Volume related Order related Customer support Other

Tk.3,00,000 1,00,000 Tk.4,00,000

Activity Measure No. of direct labor-hours No. of customer orders No. of customers These costs are not allocated to products or customers

Total Activity for the Year 20,000 DLHs 400 orders 200 customers Not applicable

Distribution of Resource Consumption Across Activities

Wages and salaries Other overhead costs

Volume Related 40% 30%

Order Related 30% 10%

Customer Support 20% 20%

Other Activities Total 10% 100% 40% 100%

During the year, Advanced products completed one order for a new customer, Shenzhen Enterprises. This customer did not order any other products during the year. Data concerning that order follow: Data concerning the Shenzhen Enterprises Order Units ordered 10 units Direct labor-hours per unit 2 DLHs Selling price Tk.300 per unit Direct material Tk.180 per unit Direct labor Tk.50 per unit Required: (1) Prepare a report showing the first-stage allocations of overhead costs to the activity cost pools. (2) Compute the activity rates for the activity cost pools. (3) Prepare a report showing the overhead costs for the order form Shenzhen Enterprises. (4) Prepare a report from the activity viewpoint showing the product margin for the order and the customer margin for Shenzhen Enterprises. (5) Prepare an action analysis of the order from Shenzhen Enterprises. For purposes of this report, direct materials should be coded as a Green cost, direct labor and wages and salaries as Yellow costs, and other overhead costs as a Red cost. CMA Adapted – December 2013 E-13. Kennelly and Sons manufactures components for the computer industry. The company uses an activity-based costing system to assign labour, manufacturing overhead and non-manufacturing costs to products. Below is a partially completed bill of activities for one of the companyâ€&#x;s major products, Switch 3901. 163


Activity Prepare purchase order Process payables Prepare payroll Process sales orders Pack and dispatch Program solder robots Solder circuits Assemble circuit boards Wire in switch Insert fuse Test switch Design switch

Cost per unit of activity driver $43 per purchase order $27 per invoice received $10 per payslip $33 per sales order $17 per sales order $153 per program $2 per solder joint $5 per board $14 per switch $10 per fuse $4 per switch $5,000 for model 3901

Annual quantity of activity driver 50 purchase orders 50 invoices 300 payslips 500 sales orders 500 sales orders 200 programs 72,000 solder joints 15,000 boards 5,000 switches 5,000 fuses 5,000 switches

These annual costs relate to an annual production level of 5,000 switches. The direct material cost per switch is $20. Required: (i) Calculate the total cost per unit for Switch 3901. (ii) Calculate the manufacturing cost per unit for Switch 3901. (iii) Discuss the role that product costs that include both manufacturing and nonmanufacturing costs can play in management decision making. CMA Adapted – August 2013 E-14. Haycarb Manufacturing produces two types of entry doors: Deluxe and Standard. The assignment basis for support costs has been direct labor dollars. For 2012, Haycarb compiled the following data for the two products: Deluxe Standard Sales units 50,000 400,000 Sales price per unit $650.00 $475.00 Direct material and labor costs per unit $180.00 $130.00 Manufacturing support costs per unit $80.00 $ 120.00 Last year, Haycarb Manufacturing purchased an expensive robotics system to allow for more decorative door products in the deluxe product line. The CFO suggested that an ABC analysis could be valuable to help evaluate a product mix and promotion strategy for the next sales campaign. She obtained the following ABC information for 2012: Activity Setups Machine-related Packing

Cost Driver of setups of machine hours of shipments

Cost $500,000 $44,000,000 $5,000,000

Total Deluxe 500 400 600,000 300,000 250,000 50,000

Standard 100 300,000 200,000

Required: a. Using the current system, what is the estimated: i. total cost of manufacturing one unit for each type of door? ii. profit per unit for each type of door? 164


b. Using the current system, estimated manufacturing overhead costs per unit are less for the deluxe door ($80 per unit) than the standard door ($120 per unit). What is a likely explanation for this? c. Review the machine –related costs above. What is a likely explanation for machinerelated costs being so high? What might explain why total machining hours for the deluxe doors (300000 hours) are the same as for the standard doors (300000 hours)? d. Using the activity-based costing data presented above, i. compute the cost –driver rate for each overhead activity. ii. compute the revised manufacturing overhead cost per unit for each type of entry door. iii. compute the revised total cost of manufacture one unit of each type of entry door. e. Is the deluxe door as profitable as the original data estimated? Why or why not? f. What considerations need to be examined when determining a sales mix strategy? CMA Adapted – April 2013 E-15. BROWN Corporation makes a single product – A fire resistant commercial filling cabinet that it sells to office furniture distributors. The company has a single ABC system that it uses for internal decision – making. The company has two overhead departments whose costs are listed as below: Manufacturing Overhead Selling & Admin. Overhead Total

Tk. 5,00,000 Tk. 3,00,000 Tk. 8,00,000

The company‟s ABC system has the following activity cost pools and activity measurers: Activity Cost Pool Assembling Unit Processing Orders Supporting Customers Other

Activity Measure Number of units Number of Orders Number of Customers Not Applicable

Costs assigned to the “Other” activity cost pool have no activity measure: they consist of unused capacity and organization sustaining cost – neither of which are assigned to Product, Orders & Customers. Brown Corporation distribution the cost of manufacturing overhead and of selling and administrative overhead to activity costs pools based on employees interviews, the result of which are reported below: Distribution of Resources Consumption Across Activity Cost Pools Assembling Units 50%

Manufacturing Overhead Selling & Admin 10% Overhead Total Activity 1000 units

165

Processing Orders 35%

Supporting Customers 5%

Other

Total

10%

100%

45%

25%

20%

100%

250 orders

100 customers


Required: (i) Perform the first stage allocation of overhead costs to the activity costs pool. (ii) Compute activity rates for activity costs pool. (iii) Office mart is one of the Brown‟s customers last year, office mart ordered filing cabinets for different times. Office Mart ordered a total of 80 filing cabinets during the year. Show the overhead costs of these 80 units and 4 orders. (iv) The selling price of filing cabinets is Tk. 595 The cost of direct material is Tk. 180 per filing cabinets, and direct labor is Tk. 50 per filing cabinet. What is the product margin on the 80 filing cabinets ordered by Office Mart. How profitable is Office Mart as a customer? CMA Adapted – December 2012 E-16. Jonson Company manufactures two products, Product A and Product B those varies significantly in terms of resource consumption. Unit costs for materials and labor are: Product A Product B Direct Material Tk.8 Tk.10 Direct Labor 4 6 One unit of Product A requires two machine hours, Product B requires three machine hours for completion. The company has only fixed machine hours and runs at capacity. Estimated indirect manufacturing costs (factory overhead) are Tk.825,000 to produce 22,000 units of Product A and 60,000 units of Product B. Required: a. Compute the predetermined overhead application rate. b. What is the cost to manufacture one unit of each product under traditional costing? c. There are some complains from the customers regarding product costs. Tom Harrison, the President, feels that there may be product cost cross-subsidization. He called upon Miss Kelly, the cost accountant recently joined the team, and asked her to apply ABC with the following information: Activity Traceable Costs Total Activity Product A Product B Machine Setups Tk.450,000 4,200 1,200 3,000 Purchase Orders 220,000 400 290 110 Material Receipts 155,000 10,300 3,000 7,300 i. Compute activity rates. ii. Compute overhead cost per unit of Product A and B. iii. Compute total cost per unit of Product A and B under ABC. iv. Do you believe that the President was right? Justify your answer. CMA Adapted – August 2012 E-17. Merlin Company recently introduces a new product, which managers refer to as special to complement their other product, regular. Accountants accumulate all overhead in a single cost pool and allocate it based on machine-hours. With the recent addition of an expanded computer system, Merlin decided to begin implementing ABC. A study reveals much overhead cost relates to machine setups and engineering changes. They select the number of setups and the number of engineering changes as the activity drivers for the two new cost pools. They will continue to use machine-hours as the base for allocating all remaining overhead. Accountant provide the following information about Merline Company‟s most recently year of operations: 166


Regular 49,800 20 22,00,000 11,000 20 400

Special 200 120 3,00,000 960 40 600

Total 25,000

Units produced Direct material cost per unit Direct labor cost (Tk.) 25,00,000 Machine hours 11,960 Machine set ups 60 Engineering charges 1,000 Overhead cost: Machine set ups related 240,000 Engineering related 836,400 Others 9,13,600 Total Overhead 9,90,000 Required: (i) Using the current costing system, determine the total and unit cost for each product line. (ii) Using the ABC costing system, determine the total and unit cost for each product line. (iii) Reconcile the total and unit costs reported for Special by the two costing system treat differently? (iv) What percentage of Merlinâ€&#x;s total overhead did the two costing system treat differently? By what percentage did the cost of Special changes as a result of the changes in system? Calculate each answer to the nearest whole percentage. CMA Adapted – December 2011 E-18. Moni Limited has a single production process for which the following costs have been estimated for the period ending 30 June 2011: Material receipt and inspection cost Power cost Material handling cost

Tk. 15600 Tk. 19500 Tk. 13650

Three product X, Y and Z are produced by workers who perform a number of operations on material blanks using hand held electrically powered drill. The workers have a wage rate of Tk. 9 per hour. The following budgeted information has been obtained for the period ending 30 June, 2011: X Y Z Production Quantity (units) 2000 1500 800 Batches of materials 10 5 16 Direct material (Sq. mater/unit) 4 6 3 Direct material (Tk.) 5 3 6 Direct labor (Minute)/unit 24 40 60 Number of power drill operation/unit 6 3 2 Material receipt and Inspection: Number of batches of materials. Process power: Number of power Drill operations. Material Handling: Quantity of material (Sq meters) handled. Required: (a) Prepare a summary which shows the budgeted product cost per unit for each of the product X, Y and Z for the period ending June 30, 2011 detailing the unit costs for each cost element: 167


(i) Using the existing method for the absorption of overhead costs. (ii) Using an approach which recognizes the cost drivers revealed in the activity based costing investigation. (iii) Discuss the implication of Moni limited making the decision to switch to activity based costing. (b) Explain the relevance of cost drivers in activity based costing. You are advised to make use of figures from the summary statement prepared in part (a) to illustrate your answer. CMA Adapted – August 2011 E-19. Proxy Health Care Ltd. produces medicine using traditional two-stage cost allocation system. In the first stage, all factory overhead costs are assigned to two production departments, A and B, based on machine-hours. In the second stage, direct labor hours are used to allocate overhead to individual products, Delux and Regular. During 2010, the Company has a total factory overhead cost of Tk.1,000,000. Machinehours in production departments A and B were 4,000 and 16,000 hours respectively. Direct labor-hours in production departments A and B were 20,000 and 10,000 respectively. The following information relates to products Delux and Regular for the month of January 2010: Delux Regular Units produced and sold 200 800 Unit cost of Direct Material Tk.100 Tk.50 Direct Labor Rate (Hourly) Tk.25 Tk.20 Direct labor hours in Dept. A (per unit) 2 2 Direct labor hours in Dept. B (per unit) 1 1 Company is considering implementing an activity-based costing system. Its management accountant has collected the following information for activity cost analysis. Activity Driver OH Rate (Tk.) Driver Consumption Delux Regular Material movement Number of production runs 20 150 300 Machine setup Number of setup 800 25 50 Inspections Number of units 30 200 800 Shipment Number of shipments 20 50 100 Calculate the unit cost for each of the two products: (i) Under existing traditional system. (ii) If the proposed ABC system is adopted. CMA Adapted – April 2011 E-20. Recently you have been appointed as Cost Accountant in Faiyaad Group. The executives of Cost Accounting department are not professional and they are not familiar with the latest developments in Cost Accounting System. After analyzing on-going system of Cost Accounting you have decided to introduce Activity based costing based on the under mentioned information: 168


Product X Y Z

Hours Per unit L.H M.H 1.5 1.5 1.5 1 1 3

Materials cost Per unit (Tk.) 20 12 25

Production Units 750 1,250 7,000

Direct labor cost Tk.6 per hour and production overheads are absorbed on a machine hour basis. The overhead absorption rate for the period under consideration is Tk.28 per machine hour. Total production overheads are Tk.6,54,500 and further analysis shows that the total production overheads can be divided as follows: Set up cost Machine related cost Material handling cost Inspection cost

35% 20% 15% 30%

The following total activity volume are associated with each product line for the period as a whole: Product X Y Z

No. of setups 75 115 480 670

No. of material movements 12 21 87 120

No. of inspection 150 180 670 1,000

Required: (a) Calculate the cost per unit for each product using traditional method (absorbing overhead on the basis of machine hour) and cost per unit for each product using ABC principles (take two decimal places for calculation). (b) What may be the implication of switch to Activity based costing on pricing and profitability. CMA Adapted – December 2010

169


CHAPTER – 5 INVESTMENT APPRAISAL

5.1. DEFINITION OF INVESTMENT APPRAISAL Investment appraisal or capital budgeting is the planning process used to determine whether an organization's long term investments such as new machinery, replacement of machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure (debt, equity or retained earnings). It is the process of allocating resources for major capital, or investment, expenditures. One of the primary goals of investment appraisal is to increase the value of the firm to the shareholders. 5.2. REASONS FOR INVESTMENT ON CAPITAL Capital investment is concerned with the deployment of capital for long-term uses. Companies make continual capital investment to sustain existing operations and expand their businesses for the future. The main type of capital investment is in fixed assets to allow increased operational capacity, capture a larger share of the market and in the process, generate more revenue. Companies may also make capital investment in the form of equity stakes in other companies' operations, which indirectly benefits the investor companies by building business partnerships or expanding into new markets. 5.3. TECHNIQUES OF INVESTMENT APPRAISAL There are a number of appraisal techniques which are used to assess how financially worthwhile investments are. These are as follows: (i) Payback: The payback technique considers the time a project will take to pay back the money invested in it. It is based on expected cash flows. To use the payback technique a company must set a target payback period. (ii) Discounted payback: The discounted payback is the amount of time that it takes to cover the cost of a project, by adding positive discounted cash flow coming from the profits of the project. The advantage of using the discounted payback period over the payback period is that it takes into account time value of money. (iii) Accounting rate of return: Accounting rate of return, also known as the Average rate of return is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. It calculates the return, generated from net income of the proposed capital investment. 170


(iv) Net Present value: The Net Present Value represents the surplus funds (after funding the investment) earned on the project. This tells us the impact the project has on shareholder wealth. (v) Internal Rate of Return: The next investment appraisal technique, which is linked to Net Present Value (NPV) is Internal Rate of Return (IRR). IRR calculates the rate of return at which the project has an NPV of Zero. The IRR is compared to the companyâ€&#x;s cost of capital (this is the target rate). 5.4. ADVANTAGES AND DISADVANTAGES OF DIFFERENT INVESTMENT APPRAISAL TECHNIQUES Advantages of Payback: a) Simple to understand. b) Simple measure of risk and uses cash flows. c) If payback is used in selecting projects, companies may avoid liquid problems. Disadvantages of Payback: a) It is not a measure of absolute profitability. b) Ignores time value of money. c) Does not take account of cash flows beyond the payback period. Advantages Accounting Rate of Return: a) Like payback period, this method of investment appraisal is easy to calculate. b) It recognizes the profitability factor of investment. Disadvantages of Accounting Rate of Return: a) It ignores time value of money. b) It can be calculated in different ways. Thus there is problem of consistency. c) It uses accounting income rather than cash flow information. Thus it is not suitable for projects which having high maintenance costs because their viability also depends upon timely cash inflows. Advantages of Net Present Value: a) Considers the time value of money. b) It is a measure of absolute profitability. c) Uses cash flows. d) Considers the whole life of the project. Disadvantages of Net Present Value: a) Fairly complex. b) Not well understood by non-financial managers. c) It may be difficult to determine the cost of capital. Advantages of Internal Rate of Return: a) Considers the time value of money. b) Uses cash flows. 171


c) Considers the whole life of the project. d) Should maximize shareholders wealth. Disadvantages Internal Rate of Return: a) Not a measure of absolute profitability. b) Fairly complicated to calculate. c) Calculation only provides an estimate. 5.5. METHOD OF DISCOUNTING Discounting is the process of determining the present value of a payment or a stream of payments that is to be received in the future. Given the time value of money, a taka is worth more today than it would be worth tomorrow. Discounting is the primary factor used in pricing a stream of tomorrow's cash flows. 5.6. NEED FOR METHOD OF DISCOUNTING (i) It can be applied for valuing business as a whole and also for valuing individual business components of a company or firm. (ii) It is simple to understand and apply and also if needed it can be modified to deal with complex circumstances also. (iii) It can be used by both equity shareholders because on the basis of DCF valuation they can compare two companies and take decision whether to invest or not, and also debt holders can use DCF method to take decision regarding the company. 5.7. DIFFERENCES BETWEEN DISCOUNTING AND COMPOUNDING Basis for comparison i) Meaning

ii) Concept

iii) Use of iv) Known as v) Factor vi) Formula

Discounting

Compounding

The method used to determine the present value of future cash flows is known as Discounting. What should be the amount we need to invest today, to get a specific amount in future. Discount rate Present value Present value factor or discounting factor A PV = n (1  i )

The method used to determine the future value of present investment is known as Compounding. If we invest some money today, what will be the amount we get at a future date. Compound interest rate Future value Future value factor or compounding factor FV = A (1 + i) n

5.8. CONCEPT OF SENSITIVITY ANALYSIS A sensitivity analysis is a technique used to determine how different values of an independent variable impact a particular dependent variable under a given set of

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assumptions. This technique is used within specific boundaries that depend on one or more input variables, such as the effect that changes in interest rates have on bond prices. 5.9. USES OF SENSITIVITY ANALYSIS (i) The key application of sensitivity analysis is to indicate the sensitivity of simulation to uncertainties in the input values of the model. (ii) They help in decision making (iii) Sensitivity analysis is a method for predicting the outcome of a decision if a situation turns out to be different compared to the key predictions. (iv) It helps in assessing the riskiness of a strategy. (v) Helps in identifying how dependent the output is on a particular input value. Analyses if the dependency in turn helps in assessing the risk associated. (vi) Helps in taking informed and appropriate decisions (vii) Aids searching for errors in the model 5.10. MEASUREMENT OF SENSITIVITY ANALYSIS Followings are the important steps used in measuring sensitivity analysis: (i) Firstly the base case output is defined; say the NPV at a particular base case input value (Value 1) for which the sensitivity is to be measured. All the other inputs of the model are kept constant. (ii) Then the value of the output at a new value of the input (Value 2) while keeping other inputs constant is calculated. (iii) Find the percentage change in the output and the percentage change in the input. (iv) The sensitivity is calculated by dividing the percentage change in output by the percentage change in input. The conclusion would be that the higher the sensitivity figure, the more sensitive the output is to any change in that input and vice versa.

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USEFUL FORMULAS 1. If the interest is compounded annually, A = P (1+i) n Here, A = Amount P = Present value i = Rate of interest n = No. of year i 2. If the interest is compounded half-yearly or semi-annually, A = P (1+ )2n 2 i 4n 3. If the interest is compounded quarterly, A = P (1+ ) 4 P 4. For annuity, A = {(1+i)n-1} i A 5. If the interest is compounded annually, P = n (1  i ) A 6. If the interest is compounded half-yearly or semi-annually, P = 2n i (1  ) 2 A 7. If the interest is compounded quarterly, P = 4n i (1  ) 4 A 1 8. For annuity, P = {1n} i (1  i ) Initial investment 9. Payback period = Annual cash flows B 10. Payback period = A + C Here, A = Last period with a negative cumulative cash flow B = Absolute value of cumulative cash flow at the end of the period A C = Total cash flow during the period after A

11. Internal Rate of Return, IRR = L +

NL (H - L) NL  NH

Here, H = Higher interest rate L = Lower interest rate NH = NPV at higher interest rate NL = NPV at lower interest rate 12. Accounting Rate of Return, ARR =

Average accounting profit Average investment

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PROBLEMS AND SOLUTIONS P-1. Find the present value of Tk.5000 due in 15 years at 5

1 % per annum compounded 2

interest. Solution: We know, if the interest is compounded annually, A PV = n (1  i ) Given, A = Tk5000 1 11 i = 5 % = % = 0.055 2 2 n = 15 years Therefore, 5000 PV = 15 (1  0.055) 5000 = 15 (1.055) 5000 = 2.2325 = Tk2239.64 P-2. How much should be invested now in order to have Tk.250 in 8 years‟ time? The account pays 12% interest per annum. Solution: We know, A PV = n (1  i ) Given, A = Tk.250 i = 12% or, 0.12 n = 8 years Therefore,

Tk.250 8 (1  0.12) Tk.250 => PV = 2.4760 => PV = Tk.101 PV =

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P-3. A man expects to receive Tk2000 in 10 years. How much is the money worth now considering interest at 6% compounded quarterly? What is the discount? Solution: We know, A PV = 4n i (1  ) 4 Given, A = Tk2000 i = 6% or, 0.06 n = 10 years PV = ? Therefore, 2000 PV = 4X10 0.06 (1  ) 4 2000 = 40 (1  0.015) 2000 = 40 (1.015) 2000 = 1.7908 = 1116.82 So, Tk1116.82 (approximately) is worth now Discount = A – PV = 2000 – 1116.82 = Tk883.18 (approximately) P-4. A project will cost Tk.300,000. The annual cash flows are estimated at Tk.90,000 per annum. Calculate the payback period. Solution: We know,

Initial investment Annual cash flows Tk.300,000 = Tk.90,000 = 3.33 years

Payback period =

The required Payback period = 3 years and (0.33 X 12) months = 3 years and 4 months 176


P-5. KLJ are considering purchasing a new machine. The machine will cost Tk.550,000. The management accountant of KLJ has estimated the following additional cash flows will be received over the next 6 years if the new machine is purchased: Year 1: Tk.40,000 Year 2: Tk.65,000 Year 3: Tk.140,000 Year 4: Tk.175,000 Year 5: Tk.140,000 Year 6: Tk.70,000 KLJ have a target payback period of 4 years. Calculate the payback period for the new machine and advise KLJ whether or not to proceed with the investment. Solution: Year 0 1 2 3 4 5 6

Cash flow (Tk.) (550,000) 40,000 65,000 140,000 175,000 140,000 70,000

Cumulative cash flow (Tk.) (550,000) (510,000) (445,000) (305,000) (130,000) 10,000 80,000

130,000 X 12 months 140,000 = 4 years and 11 months

The payback period for the new machine = 4 years and

KLJ have a target payback period of 4 years. But we got the payback after this target. So, KLJ is advised to not undertake the investment. P-6. An initial investment of Tk.500,000 is expected to generate annual cash inflow of Tk.150,000 for 4 years. Depreciation is allowed on the straight line basis. It is estimated that the project will generate scrap value of Tk.100,000 at end of the 4th year. Calculate its accounting rate of return assuming that there are no other expenses on the project. Solution:

Initial investment  Scrap value Useful life in years Tk.500,000  Tk.100,000 = 4 = Tk.100,000

Annual depreciation =

Average Accounting Income = Tk.150,000 – Tk.100,000 = Tk.50,000 Accounting Rate of Return = Tk.50,000 ÷ Tk.500,000 = 10% 177


P-7. Compare the following two mutually exclusive projects on the basis of ARR. Cash flows and salvage values are in thousands of Taka. Use the straight line depreciation method. Project A 0 - 450

Year Cash outflow Cash inflow Salvage value

Project B 0 -700

Year Cash outflow Cash inflow Salvage value

1

2

3

150

200

200 50

1

2

3

250

300

400 100

Solution: Project A:

Initial investment  Scrap value Useful life in years Tk.450,000  50,000 = 4 = Tk.100,000

Annual depreciation =

Determination of accounting income: Year Cash inflow Salvage value Depreciation Accounting income

1 150,000

2 200,000

(100,000) 50,000

(100,000) 100,000

3 200,000 50,000 (100,000) 150,000

Tk.50,000  Tk.100,000  Tk.150,000 3 = Tk.100,000

Average accounting income =

Tk.100,000 Tk.450,000 = 0.22

Accounting rate of return =

Project B:

Initial investment  Scrap value Useful life in years Tk.700,000  100,000 = 4 = Tk.150,000

Annual depreciation =

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Determination of accounting income: Year Cash inflow Salvage value Depreciation Accounting income

1 250,000

2 300,000

(150,000) 100,000

(150,000) 150,000

3 400,000 100,000 (150,000) 350,000

Tk.100,000  Tk.150,000  Tk.350,000 3 = Tk.200,000

Average accounting income =

Tk.200,000 Tk.700,000 = 0.29

Accounting rate of return =

Since the ARR of the project B is higher than the project A, it is more favourable. P-8. Consider the following cash flows for a project with an initial investment of Tk.30,000. Year 1 2 3 4 5

Cash flow Tk.5,000 Tk.8,000 Tk.10,000 Tk.7,000 Tk.5,000

Assume an interest rate of 10%. Calculate Net Present Value (NPV) of the project and comment on the result. Solution: Calculation of Net Present Value (NPV): Year 0 1 2 3 4 5

Cash flow (Tk.) (30,000) 5,000 8,000 10,000 7,000 5,000

PV factor @ 10% 1.000 0.909 0.826 0.751 0.683 0.621 NPV =

Present Value (Tk.) (30,000) 4,545 6,608 7,510 4,781 3,105 (3,451)

Here, NPV is negative Tk.3,451. The decision rule is that projects with a positive NPV should be accepted and those with a negative NPV should be rejected, therefore in this case the project should be rejected.

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P-9. Kramer Company has two investment proposals. Data concerning the two projects are given below: Project-A Project-B Investment in high-speed photocopier Tk.50,000 Investment in working capital Tk.50,000 Net annual cash inflow 10,000 9,000 Life of the project 8 years 8 years The high-speed photocopier will have a salvage value of Tk.5,000 in eight years. The company requires 10% return on investment. The tax rate is 30%. The photocopier would be depreciated over eight years under straight-line method assuming zero salvage value. Compute the net present value of each investment proposal. Solution: Computation of net cash inflow from each investment proposal:

Net annual cash inflow Depreciation per year (Tk.50,000 ÷ 8) Operating profit Income tax @ 30% Net cash inflow after tax (10,000 – 1,125), (9,000 – 2,700)

Project-A Tk.10,000 6,250 3,750 1,125 8,875

Computation of net present value of each investment proposal: Year Discounting Project A @ 10% Cash flow P.V. 0 1.000 (50,000) (50,000) 1–8 5.334 8,875 47,339.25 8 0.467 (5,000 – 1,500) 1,634.50 Net present value (1,026.25)

Project-B Tk.9,000 ___9,000 2,700 6,300

Project A Cash flow P.V. (50,000) (50,000) 6,300 33,604 50,000 23,350 6,954

Thus, NPV of: Project A = (Tk.1,026.25) Project B = Tk.6,954 P-10. Safar Limited is considering two mutually exclusive projects with the following details: Cash flows Year Project A Project B (Tk) (Tk) 0 45,000 10,000 1 20,000 5,000 2 15,000 4,000 3 10,000 3,000 4 10,000 2,000 5 10,000 2,000 180


Assume that the first investment is made at the start of the period of the project and the annual cash flows are at the end of each year. Scrap value in year 5 is Tk.2,000 for Project A and Tk.1,000 for Project B. The scrap values should be treated as cash inflows in year 5. Required: Calculate the Net Present Value for the both projects if the relevant cost of capital is 10%. Which project would you recommended using the NPV technique? Solution: Calculation of Net Present Value:

Year 0 1 2 3 4 5

PV factor @10% 1.000 0.909 0.826 0.751 0.683 0.621

Project A Cash flows Present (Tk.) value (Tk.) (45,000) (45,000) 20,000 18,180 15,000 12,390 10,000 7,510 10,000 6,830 12,000 7,452 NPV = 7,362

Project B Cash flows Present (Tk.) value (Tk.) (10,000) (10,000) 5,000 4,545 4,000 3,304 3,000 2,253 2,000 1,366 3,000 1,863 NPV = 3,331

Project A has an NPV of Tk.7,362 and Project B has an NPV of Tk.3,331. So, Project A should be recommended. P-11. The following information relates to three possible capital expenditure projects, out of which one project can be accepted: Project-X Project-Y Project-Z Particulars Initial Cost (Tk.) 200,000 230,000 180,000 Estimated Life (Years) 5 5 4 Expected Scrap Value (Tk.) 10,000 15,000 8,000 Expected Cash Inflow (Tk.) Year-1 80,000 100,000 55,000 Year-2 70,000 70,000 65,000 Year-3 65,000 50,000 95,000 Year-4 60,000 50,000 100,000 Year-5 55,000 50,000 --The company estimates that its cost of capital is 18%. Required: (a) The payback period for each project. (b) The Accounting Rate of Return for each project. (c) NPV of each project. (d) Which project should you accept? Why?

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Solution: (a) Project-X: Year

Beginning un-recorded Cash inflows investment (Tk.) (Tk.) 1 2,00,000 80,000 2 1,20,000 70,000 3 50,000 65,000 Tk.50,000 So, payback period = 2 years + years Tk.65,000 = 2.77 years Project-Y: Year

Beginning un-recorded investment (Tk.) 2,30,000 1,30,000 60,000 10,000

1 2 3 4

So, payback period = 3 years +

Cash inflows (Tk.) 100,000 70,000 50,000 50,000

Beginning un-recorded investment (Tk.) 1,20,000 50,000 -

Beginning un-recorded investment (Tk.) 1,30,000 60,000 20,000 -

Tk.10,000 years Tk.50,000

= 3.20 years Project-Z: Year

Beginning un-recorded investment (Tk.) 1,80,000 1,25,000 60,000

1 2 3

So, payback period = 2 years +

Cash inflows (Tk.) 55,000 65,000 95,000

Beginning un-recorded investment (Tk.) 1,25,000 60,000 -

Tk.60,000 years Tk.95,000

= 2.63 years (b) The Accounting Rate of Return =

Average EAT X 100 Average investment

Tk.16,800 X 100 Tk.1,00,000 = 16.80%

Project-X =

Tk.12,600 X 100 Tk.1,15,000 = 10.96%

Project-Y =

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Tk.21,450 X 100 Tk.90,000 = 23.83%

Project-Z =

(c) Net Present Value (NPV): Project-X Project-Y Project-Z

(Tk.20,476) (Tk.41,747) Tk.7,927

(d) Project Z should be accepted for the following reasons: - Its payback period is lowest; - Its ARR is the highest; - Its NPV is positive. P-12. You are given the following data on project Z: At 10% the NPV is Tk.33,310 At 20% the NPV is Tk.8,510 At 30% the NPV is –Tk.9,150 Calculate the Internal Rate of Return (IRR) for project Z. Solution: We know, IRR = L +

NL (H - L) NL  NH

Here, H = 30% L = 10% NH = -Tk.9,150 NL = Tk.33,310

33,310 X (30 - 10) 33,310  (9,150) 33,310 = 10 + X 20 42,460 = 10 + 15.6901 = 25.7%

IRR = 10 +

P-13. Singer wants to buy a numerically controlled NC equipment to be used in producing special machined parts for manufacturer of trenching machines. The outlay required is Tk.800,000. The NC equipment will last five years with no expected salvage value. The expected after tax cash flows associated with the project are as follows:

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Year 1 2 3 4 5

Cash Revenue 13,00,000 14,50,000 16,00,000 14,00,000 12,00,000

Cash Expenses 10,00,000 11,00,000 12,00,000 11,50,000 9,50,000

Required: (a) Compute the Pay Back period for the NC equipment. (b) Compute the NC equipmentâ€&#x;s Accounting Rate of Return on Initial Investment. (c) Compute the NPV assuming a required rate of return of 10%. (d) Compute the IRR. Solution: Calculation of cash flows: Year 1 2 3 4 5

Cash Revenue (Tk.) 13,00,000 14,50,000 16,00,000 14,00,000 12,00,000

Cash Expenses (Tk.) 10,00,000 11,00,000 12,00,000 11,50,000 9,50,000 Total

Cash Flows (Tk.) 3,00,000 3,50,000 4,00,000 2,50,000 2,50,000 15,50,000

(a) Computation of payback period: Year

Cash Flows (Tk.) (8,00,000) 3,00,000 3,50,000 4,00,000

0 1 2 3

Cumulative Cash Flows (Tk.) (8,00,000) (5,00,000) (1,50,000) 2,50,000

Tk.1,50,000 Tk.4,00,000 = 2.375 years

Payback period = 2 years +

(b) Calculation of Accounting Rate of Return: Net cash flows throughout the life period Investment Profit Tk.7,50,000 Average annual profit = 5 years = Tk.1,50,000

Tk.15,50,000 8,00,000 Tk.7,50,000

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Tk.8,00,000 2 years = Tk.4,00,000

Average investment =

Tk.1,50,000 X 100 Tk.4,00,000 = 37.50%

Accounting rate of return =

(c) Calculation of NPV: Year 0 1 2 3 4 5

Cash flows (Tk.) (8,00,000) 3,00,000 3,50,000 4,00,000 2,50,000 2,50,000

PV factor @ 10% 1.000 0.909 0.826 0.751 0.683 0.621 NPV =

Present Value (Tk.) (8,00,000) 2,72,700 2,89,100 3,00,400 1,70,750 1,55,250 3,88,200

(d) Calculation of IRR: Year 0 1 2 3 4 5

Cash flows (Tk.) (8,00,000) 3,00,000 3,50,000 4,00,000 2,50,000 2,50,000

PV factor @ 28% 1.000 0.781 0.610 0.477 0.373 0.291

PV (Tk.) (8,00,000) 2,34,300 2,13,500 1,90,800 93,250 72,750 4,600

4,600 X (30 – 28) 4,600  (25,350) 4,600 = 28 + X2 29,950 = 28 + 0.3072 = 28.31

IRR = 28 +

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PV factor @ 30% 1.000 0.769 0.592 0.455 0.350 0.269

PV (Tk.) (8,00,000) 2,30,700 2,07,200 1,82,000 87,500 67,250 (25,350)


CHAPTER - 6 DEALING WITH UNCERTAINTY IN ANALYSIS

6.1. DEFINITION OF RISK Risk implies future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty that an investor is willing to take to realize a gain from an investment. 6.2. TYPES OF RISK There are two types of risk: Positive and Negative. The response of the project manager, team, the management, and the other stakeholders varies for both. Positive Risks are regarded as opportunities and proactive measures are taken to increase them. Negative risks can compromise success of a project therefore the team and project manager must make efforts to minimize these risks. 6.3. NATURE OF RISK AND UNCERTAINTY (i) Risk is universal (ii) Risk and uncertainty is not properly identified and managed by most organisations, including governments (iii) It depends on the nature of business (iv) It changes with the size of business enterprise (v) Risk and uncertainties are diverse and inherent to the business operations (vi) It arises from failure on part of others 6.4. SENSITIVITY ANALYSIS IN DECISION MODELING Sensitivity analysis yields useful information for planners through simple applications and through testing of more complex decision models such as multi-objective decision models. These models are used in several planning sectors, including social indicators, intergovernmental allocations, major facility siting, transportation and infrastructure planning, and regional planning. Sensitivity analysis uses as indicators that were developed for testing allocation and multi-objective decision models are presented in two cases where testing with these indicators enhanced the decision-making process. This experience revealed that complex decision models may be inherently unstable, and that sensitivity analysis is essential for testing the abstract structure of such models against their structures in practice. 6.5. CONCEPT OF DECISION TREE A decision tree is a flowchart-like structure in which each internal node represents a "test" on an attribute (e.g. whether a coin flip comes up heads or tails), each branch represents the outcome of the test and each leaf node represents a class label (decision taken after computing all attributes). Decision trees are commonly used in operations

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research and operations management. Decision trees influence diagrams, utility functions and other decision analysis tools. 6.6. USESS OF DECISION TREE A decision tree can be used in either a predictive manner or a descriptive manner. In either instance they are constructed the same way and are always used to visualize all possible outcomes and decision points that occur chronologically. Decision trees are most commonly used in the financial world for areas such as loan approval, portfolio management, and spending. A decision tree can also be helpful when examining the viability of a new product or defining a new market for an existing product. 6.7. DRAWING A DECISION TREE To draw a decision tree, first pick a medium. You can draw it by hand on paper or a whiteboard, or you can use special decision tree software. In either case, here are the steps to follow: (i) Start with the main decision. Draw a small box to represent desired point and then draw a line from the box to the right for each possible solution or action. Label them accordingly. (ii) Add chance and decision nodes to expand the tree as follows: - If another decision is necessary, draw another box. - If the outcome is uncertain, draw a circle (circles represent chance nodes). - If the problem is solved, leave it blank. From each decision node, draw possible solutions. From each chance node, draw lines representing possible outcomes. If you intend to analyze your options numerically, include the probability of each outcome and the cost of each action. (iii) Continue to expand until every line reaches an endpoint, meaning that there are no more choices to be made or chance outcomes to consider. Then, assign a value to each possible outcome. It could be an abstract score or a financial value. Add triangles to signify endpoints. With a complete decision tree, youâ€&#x;re now ready to begin analyzing the decision you face. 6.8. ADVANTAGES OF DECISION TREE (i) It simple to understand and interpret. People are able to understand decision tree models after a brief explanation. (ii) It has value even with little hard data. Important insights can be generated based on experts describing a situation (its alternatives, probabilities, and costs) and their preferences for outcomes. (iii) It allows the addition of new possible scenarios (iv) It helps to determine worst, best and expected values for different scenarios (v) It can be combined with other decision techniques.

187


6.9. LIMITING FACTOR ANALYSIS In management accounting, limiting factor refers to the constraints in availability of production resources (e.g. shortage in labour, machine hours or materials) that prevent a business from maximizing its sales. Single limiting factor analysis: When there is one limiting factor, we use single limiting factor analysis to help companies to identify the scarce resources and maximize profit by using the best combination of available resource. In single limiting factor analysis, we should identify the bottleneck resources first. Secondly, we should calculate the contribution per unit for each product. Next, we should calculate the contribution per unit of the bottleneck resource for each product. After we get the contribution per unit of bottleneck resource, we can rank the products of the contribution per unit of bottleneck resource. Finally, we can allocate the resources from the highest contribution per profit to the lowest contribution per profit by the ranking. By doing so, we can obtained the greatest possible profit when resources are limited by single limiting factor. Multiple limiting factor analysis: When there is more than one of scare resources which restricts organisation's activities, we use multiple limiting factor analysis to solve the problem. Firstly, we must define the variances when we use multiple limiting factor analysis. After this, we can define and formulate the objective. Thirdly, we can formulate the constraints to formulating the problem. Next, we must draw a graph to identify the feasible region and we can get the optimum production plan from the graph. Finally, we can solve the problem and get the maximum contribution by doing so. 6.10. MAKE OR BUY DECISION A make-or-buy decision is the act of choosing between manufacturing a product in-house or purchasing it from an external supplier. In a make-or-buy decision, the most important factors to consider are part of quantitative analysis, such as the associated costs of production and whether the business has the capacity to produce at required levels. 6.11. FACTORS INFLUENCING MAKE OR BUY DECISION Two primary factors which have a decisive influence on the choice of make or buy are the cost and availability of production capacity. Facilities are made available and other things being equal cost consideration assumes primacy. If the cost of making an item in-house is going to be higher than the cost of acquiring it from an outside supplier, the choice is to buy it. On the other hand, if the cost of making the item in one of its own plant is cheaper than buying it from the supplier, the choice is to make it. Considerations which favor making an item: 1. Cost considerations less expensive to make the part 2. Needs to maintain direct control over production and quality 3. Design secrecy. 4. Unreliable suppliers. 5. No suitable supplier quotation 6. Desire to maintain a stable workforce in periods of declining sales 188


Considerations which favor buying an item: 1. Cost considerations less expensive to buy the part 2. Small volume requirements 3. Limited production facilities 4. Desire to maintain stable workforce in periods of rising sales. 5. Desire to maintain multiple source policy. 6. Monopoly items which are rationed by the government and on which, the buyer has no option. 6.12. SALES MIX ANALYSIS A sales mix is the variety of products sold by a company. It is the collection of all of the products and services a company offers. It considers each individual item a company sells and the profit margin each product earns. While every product may have a different profit margin, the sales mix considers the profit margin of all of the items combined. 6.13. IMPORTANCE OF SALES MIX ANALYSIS The sales mix analysis is important because it can reveal important information about profitable products, not profitable products, products that are top performers, products that sell in very small quantities, products which are sold generally together, etc. The overall goal of this approach is for management to define the optimal mix of products which should be sold by the company and identify new potential products that can be added to the product portfolio. In most cases business organizations will try to maximize the overall profitability by creating a sales mix of products that support overall profits and not individual profitability. Generally the common wisdom and common sense is to push with high margin products and get rid of low margin products and services.

189


PROBLEMS AND SOLUTIONS P-1. The parts division of Nobbodoy Company uses a special component in assembling its product. The components in processes are used by both the Assembly Division as well as outsiders. The Assembly Division incorporates these components into a final product. Top management has organized each division into separate profit centers. The following analysis is obtained from each segments record: Parts Division – variable cost Assembly Division – variable cost Market price – components Market price – final product

Tk.110 Tk.370 Tk.425 Tk.500

Required: (a) Supporting your answer with quantitative analysis, indicate the condition under which transfers should be made to the Assembly Division. (b) At what price do you believe transfers should be made assuming the conditions exist that you suggested in requirement (a). Solution: (a) Market price of the components Variable cost of Parts Division Contribution per component

Tk.425 Tk.110 Tk.315

As Parts Division is considered as a profit center, the department may transfer the component to the Assembly Division at market price, i.e. Tk.425. But if there is a limited demand of component in the market and Parts Division have excess capacity then they may transfer the component at cost to maximize the overall profitability of the company. (b) Maximum transfer price would be Tk.425, i.e. the market price. Parts Division may offer a lesser amount to Assembly Division, as there is no marketing cost at the time of the inter-departmental transfer. What will be the transfer price, it depends on the negotiation of both departments. Transfer price may be at a cost also, if the market demand is lower the production capacity of the Parts Division. This cost may be the variable cost only or the full cost or even the variable cost plus a portion of fixed cost. P-2. A practicing Cost Accountant now spends Tk.12 per km on taxi fares for his clients work. He is considering two other alternatives, the purchase of a new small car or an old bigger car. New small car Old big car Tk. Tk. Purchase price 8,00,000 4,00,000 Sales price after ten years 2,00,000 100,000 Maintenance cost per annum 15,000 25,000 Insurance per annum 20,000 10,000 190


Diesel consumption per liter to run 10 kms Diesel Price, per liter Tk.60 He is estimates that he can run 1,00,000 kms annually. Required: (a) Which of the three alternatives will be cheapest? (b) At how many kms per annum will the cost of two cars break-even?

8 kms Tk.60

Solution: (a)

Comparative Statement Taxi New small car (Tk.) (Tk.)

Fixed cost per annum: Depreciation Tk.800,000  Tk.200,000 10 years Tk.400,000  Tk.100,000 10 years Maintenance Insurance Total fixed cost Variable cost per annum: Diesel 100,000 kms X Tk.60 10kms 100,000 kms X Tk.60 8 kms Fare (100,000 kms X Tk.12) Total variable cost Total cost

-

60,000 30,000

-

15,000 20,000 95,000

-

6,00,000

12,00,000 12,00,000 12,00,000

6,00,000 6,95,000

Difference in total variable cost = Tk.750,000 – Tk.600,000 = Tk.150,000

Tk.150,000 100,000 kms = Tk.1.5 per km

Difference in total variable cost per km =

Tk.30,000 Tk.1.5 = 20,000 kms

191

25,000 10,000 65,000

7,50,000

As, the total cost of new small car is lowest, so it is the cheapest alternative. Difference in total fixed cos t (b) We know, Break-even kms = Difference in total var iable cos t per km Here, Difference in total fixed cost = Tk.95,000 – Tk.65,000 = Tk.30,000

Break-even kms =

Old big car (Tk.)

7,50,000 8,15,000


P-3. Beta Company manufactures three products A, B and C. All the products are manufactured using the same machinery. The following manufacturing cost data are available, together with the purchase prices from an outside supplier: A B C Tk. Tk. Tk. Production cost: Direct material 20 30 25 Direct labour 30 20 10 Variable overhead 15 10 5 Fixed overhead 10 5 5 Total 75 65 45 Purchase price from outside supplier 80 70 35 Required: Which, if any, components should be purchased from the outside supplier? Solution:

Variable production cost Purchase price from outside suppliers Incremental (cost) / saving

A Tk. 65 80 (15)

B Tk. 60 70 (10)

C Tk. 40 35 5

In this case, Beta Company should purchase product C externally, product A and B manufactures internally. P-4. A company manufactures and markets three products A, B, C. All the three products are made from the same set of machines. Production is limited by machine capacity. From data given below indicate priorities for products A, B and C with a view to maximize profits: Product-A Product-B Product-C Tk. Tk. Tk. Raw materials cost (per unit) 30 40 50 Direct labour (per unit) 20 20 30 Other variable cost (per unit) 10 30 20 Selling price (per unit) 100 200 300 Standard machine time required (per unit) 0.5 hrs 1 hr 2 hrs Raw materials required (per unit) 4 kg 10 kg 8 kg Required: How would product priorities change? Solution: Comparative profitability statement Particulars Product-A Product-B (Tk.) (Tk.) Selling price (per unit) 100 200 Less. Variable cost (per unit): Raw material 30 40 Direct labour 20 20 Other variable cost 10 30

Product-C (Tk.) 300 50 30 20 192


Total variable cost Contribution margin Contribution per hour of standard machine time (CM รท Standard machine time) Contribution per kg of raw material (CM รท Kg of raw material)

60 40 80

90 110 110

100 200 100

10

11

25

Conclusion: (a) If raw material is the key factor, contribution per kg of raw material should be considered. As product-C provides highest contribution, so it is most profitable, then product-B and at last product-A. (b) If capacity of the machine is the key factor, contribution per hour of standard time should be considered. As product-B provides highest contribution, so it is most profitable, then product-C and at last product-A. P-5. Hypro Company produces different kinds of product using single machinery. The following production cost data are available regarding the products A, B and C. A B C Tk. Tk. Tk. Direct material 30 40 20 Direct labour 40 10 30 Variable overhead 20 14 10 Fixed overhead 10 26 20 Total 100 90 80 Purchase price from external source 100 80 90 Further details of A, B and C are given below: Machine hours per unit

A 2

B 8

C 10

Manufacturing requirements show a need for 2,000 units of each product per month. The maximum number of machine hours available per month is 32,000. Required: What product should be purchased from the external source? Solution:

Variable production cost Purchase price from outside suppliers Incremental cost Machine hours per unit Incremental cost per machine hour

A Tk. 90 100 (10) 2 (Tk.5)

B Tk. 64 80 (16) 8 (Tk.2)

C Tk. 60 90 (30) 10 (Tk.3)

If capacity of the machine is the key factor, incremental cost per machine hour should be considered. Hence, product should be produced in the sequence: B, C and A. 193


Machine hours required to produce 2,000 units of each product: (2,000 X 2) + (2,000 X 8) + (2,000 X 10) = 4,000 + 16,000 + 20,000 = 40,000 machine hours The company only has 32,000 machine hours available. So, 8,000 hours (40,000 – 32,000) of work must be sub-contracted. The cheapest product per machine hour must be bought externally. This is product B. Required units =

8,000 machine hours 8 machine hours = 1,000 units

So, 1,000 units of product B should be purchased from external source. P-6. Isamoti Jewelers Ltd. is considering a special order for 10 handcrafts gold bracelets to be given as gifts to members of a wedding party. The normal selling price of a gold bracelet is Tk.389.95 and its unit product cost is Tk.264 as shown below: Items Materials Direct labor Manufacturing overhead Unit product cost

Taka 143 86 35 264

Most of the manufacturing overhead is fixed and unaffected by various in how much jewelry is produced in any given period. However, Tk.7 of the overhead is variable with respect to the number of bracelets produced. The customer who is interested in the special bracelet order would like special filigree applied to the bracelets. This filigree would require additional materials costing Tk.6 per bracelet and would also require acquisition of a special tool costing Tk.465 that would have no other use once the special order is completed. This order would have no effect on the company‟s regular sales and the order could be fulfilled using the company‟s existing capacity without affecting any other order. Required: (a) What effect would accepting this order have no the company‟s net operating income if a special price of Tk.349.95 is offered per bracelet for this order? (b) Should special order be accepted at this price? Solution: (a) Only the incremental cost and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.

194


Incremental revenue Incremental costs: Variable costs: Materials Direct labor Variable manufacturing overhead Special filigree Total variable costs Fixed costs: Purchase of special tool Total incremental costs Incremental net operating income

Per unit Taka 349.95

Total (10 bracelets) Taka 3,499.5

143 86 7 6 242

1,430 860 70 60 2,420 465 2,885 614.5

(b) Even though the price for the special order is below the company‟s regular price for such an item, the special order would add to the company‟s net operating income and should be accepted. This conclusion would not necessarily follow, if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource. P-7. Ema Company receives an order from one of its regular customer. The company desires to determine the amount that should be offered to the customer. At present, the company‟s policy is to mark–up by 10% on full cost of the product. The Cost Accountant presents the following cost data: Direct material Direct Labour Overhead Full product cost

Tk.400,000 Tk.200,000 Tk.100,000 Tk.700,000

Required: (a) Based on the company‟s pricing policy and estimated data of Cost Accountant, what is the amount the company should offer to the customer? (b) If all direct costs and 20% of overhead costs are incremental costs. Determine the incremental costs of the order. Solution: (a) Determination of the total amount that should be offered to the customer: Full product cost Tk.700,000 Add. Mark-up @ 10% 70,000 Total Tk.770,000 (b) Determination of the incremental cost of the order: Direct materials Direct labour 20% of overhead cost Incremental cost

195

Tk.400,000 200,000 20,000 Tk.620,000


P-8. Neo Manufacturing Company offers its products to the customers for various prices ranging from Tk.10,000 to Tk.100,000. Recently, the company offers following price quotation for one of its products: Direct materials Direct labor Overhead

Tk.10,000 6,000 4,000 Tk.20,000 2,000 Tk.22,000

Mark-up Sales price

Total overhead has been estimated at Tk.100,000 of which Tk.60,000 is fixed and the remainder is variable. Required: (a) Compute the difference in profit for the year if a customer offers of Tk.20,000 instead of Tk.22,000 price quotation shown as above. (b) Determine the minimum sales price the company could have quoted without reducing or increasing profit. Solution: (a) Computation of the difference in profit: Sales price Less: Variable cost: Direct materials Direct labor Variable overhead (w-1)

Tk.20,000 Tk.10,000 6,000 1,600 Tk.17,600 Tk.2,400

Increase in profit (b) Minimum sales price without reducing or increasing profit = Sales price – Increase in profit = Tk.20,000 – Tk.2,400 = Tk.17,600 Working: 1. Calculation of variable overhead: According to the question, Variable overhead = Tk.100,000 – Tk.60,000 = Tk.40,000

Tk.40,000 X Tk.4,000 Tk.100,000 = Tk.1,600

Required variable overhead =

196


P-9. Mdina Steel Company is a decentrally organized. One of its divisions manufactures large steel ball bearing for sale to other division as well as to outside. Company Management treat Bearing Division as a project center. The normal selling price for a box of ball bearing is Tk.840, cost of each box are shown below: Taka Direct material 140.00 Direct labor 98.00 Variable overhead 56.00 Fixed overhead (based on production of 700,000 boxes) 192.50 Variable selling expenses 35.00 Another division of the company wants to purchase 25,000 boxes a ball bearing from Bearing Division during next year. No selling costs are incurred sales. Required: (a) If Bearing Manager can sell all the ball bearing to the outside, what would be the minimum transfer price? (b) Assume that Bearing Division is experiencing a slight slowdown in external demand and only be able to sell 680,000 boxes of ball bearing to outside. What should be the minimum selling price in this situation? Solution: (a) Minimum transfer price = Sales price – variable selling expenses = Tk.840 – Tk.35 = Tk.805 (b) Minimum transfer price would be as follows:

Direct material Direct labor Variable overhead Fixed overhead

Per unit Tk. 140.00 98.00 56.00 192.50 486.50

P-10. Mr. Kent, Marking Directing of RK Limited, has collected the following information on price and demand of its new product RK: Price/Unit (Tk.) 18 20 22 24 26

Demand (Unit) 84,000 76,000 70,000 64,000 54,000

Mr. Tonay, the Finance Director of the company, has suggested that cost-plus approach should be used for pricing of RK with a profit mark-up of 20%. The Finance Director has prepared the budget incorporating 1,00,000 units of RK with variable cost per unit of Tk.10 and total fixed costs Tk.6,00,000. 197


Required: (a) What will be per unit price according to Mr. Kent? (b) What will be per unit price according to Mr. Tony? (c) What would be the negative consequences, if Mr. Tonyâ€&#x;s pricing approach is followed? Solution: (a) Price/unit Tk. 18 20 22 24 26

CM/unit Tk. 8 10 12 14 16

Units demand 84,000 76,000 70,000 64,000 54,000

Total CM Tk. 672,000 760,000 840,000 896,000 864,000

Fixed cost Tk. (600,000) (600,000) (600,000) (600,000) (600,000)

Net profit Tk. 72,000 160,000 240,000 296,000 264,000

Price per unit according to Mr. Kent will be Tk.24 because net profit will be maximized at that price. (b) Variable cost per unit Tk.600,000 Fixed cost per unit ( ) 100,000 Total cost Mark-up (25% of cost) Price per unit according to Mr. Tony

Tk.10 6 16 4 20

(c) Negative consequences of cost-plus pricing approach: - At price of Tk.20 per unit, demand will be 76,000 units; leaving closing stock of 24,000 units; - The price will not be the best price and at this price, Tk.136,000 (Tk.296,000 – Tk.160,000) will be the loss in income in comparison to the best price of Tk.24 per unit. E-11. Miss. Farzana owns an ice cream stand that she operates during the summer months in National Park. Miss. Farzana is unsure of how she should price her ice cream cones and has experimented with two prices in successive weeks during the busy July season. The number of people who entered the store was roughly the same in the two weeks. During the first week, she priced the cones at Tk.18.00 and 860 cones were sold. During the second week, she priced the cones at Tk.14.00 and 1,340 cones were sold. The variable cost of a cone is Tk.4.50 and consists solely of the costs of the ice cream and of the cone itself. The fixed expenses of the ice cream stand are Tk.4,250 per week. Required: (a) Did Miss. Farzana make more money selling the cones for Tk.18.00 or for Tk.14.00? (b) Estimate the price elasticity of demand for the ice cream cones.

198


Solution: (a) Price Tk.18.00 15,480.00 3,870.00 11,610.00 4,250.00 7,360.00

Sale price Less. Variable cost Total contribution Less. Fixed cost Operating profit

Price Tk.14.00 18,760.00 6,030.00 12,730.00 4,250.00 8,480.00

As profit is higher at a sale price of Tk.14.00 per cone, so Miss. Farzana make more money selling the cones for Tk.12.00.

ln (1  % change in quantity sold ) ln (1  % change in price) 18,760  15,480 ln (1  ( ) 15,480 = 14.00  18.00 ln (1  ) 18.00 ln (1  0.212) = ln (1  0.222) ln (1.212) = ln (0.778) 0.192 =  0.251 = - 0.76

(b) The price elasticity of demand =

P-12. Nova Brick Inc. manufactures bricks using clay deposits on the company‟s property. Raw clays are blended and then extruded into molds to form unfired bricks. The unfired bricks are then stacked onto movable metal platforms and rolled into the kiln where they are fired until dry. The dried bricks are then packaged and shipped to retail outlets and contractors. The bottleneck in the production process in the kiln, which is available for 2,000 hours per year. Data concerning the company‟s four main products appear below. Products are sold by the pallet. Traditional Textured Cinder Roman Brick Facing Block Brick Gross revenue per pallet Tk.789 Tk.1,264 Tk.569 Tk.836 Contribution margin per pallet Tk.370 Tk.497 Tk.328 Tk.390 Annual demand (pallets) 120 80 180 70 Hours required in the kin per pallet 5 7 4 6 No fixed cost could be avoided by modifying how much is produced of any product.

199


Required: (a) Is there sufficient capacity in the kin to satisfy demand for all products? (b) What is the production plan for the year that would maximize the companyâ€&#x;s profit? (c) The kin could be operated for more than 2,000 hours per year by running it after normal working hours. Up to how much per hour should the company be willing to pay in overtime wages, energy costs, and other incremental costs to operate the kin additional hours? (d) The company is considering introducing a new product, glazed venetian brick, whose variable cost would be Tk.530 per pallet and that would require 11 hours in the kin per pallet. What is the minimum acceptable selling price for this new product? (e) Salespersons are currently paid a commission of 5% of gross revenues. Will this motivate the salespersons to make the right choices concerning which products to sell most aggressive? Solution: (a) There is not enough kin capacity to satisfy demand for all four products. The total amount of time available is 2,000 hours, but 2,300 hours would be required to satisfy demand as shown below: Traditional Textured Cinder Roman Total Brick Facing Block Brick Annual demand in pallets (a) 120 80 180 70 Hours required in drying kin per 5 7 4 6 pallet (b) Total hours required in drying kin 600 560 720 420 2,300 (a) X (b) (b) The profitability index should be used to rank the products:

Contribution margin per pallet (a) Hours required in the kin per pallet (b) Profitability index (a) á (b) Ranking on Profitability index

Traditional Brick Tk.370 5 74 2

Textured Facing Tk.497 7 71 3

Cinder Block Tk.328 4 82 1

Roman Brick Tk.390 6 65 4

The most profitable use of the bottleneck operation (the constraints) is the Cinder Block product, followed by the Traditional Brick product and then the Textured facing and Roman Brick products. Since no fixed costs would be affected by this decision, the optimal plan would be: Amount of constrained resource available Less. Constrained resource required for production of 180 pallets of Cinder Block Remaining constrained resource available Less. Constrained resource required for production of 120 pallets of Traditional Brick Remaining constrained resource available Less. Constrained resource required for production of 80 pallets of Textured Facing

2,000 hours 720 hours 1,280 hours 600 hours 680 hours 560 hours 200


Remaining constrained resource available Less. Constrained resource required for production of 20 pallets of Roman Brick Remaining constrained resource available

120 hours 120 hours 0 hour

(c) The company should be willing to pay up to Tk.65 per hour to operate the kin until demand is satisfied for Roman Bricks. (d) The selling price for the new product should at least cover its variable cost and opportunity cost: Selling price of the new product

Variable > cost of the new product

(Opportunity cost per + unit of the constrained resources

x

Amount of constrained resource required by a unit of new product)

Selling price of the new product

> Tk.150

+ (Tk.65 per hour

x

11 hours)

= Tk.530 = Tk.1,245

+ Tk.715

(e) Salespersons who are paid a commission of 5% of gross revenues will naturally prefer to sell a customer a pallet of anything other than Cinder Blocks since they have the lowest gross revenues. However, given the companyâ€&#x;s constraint, they are in fact the companyâ€&#x;s most profitable product. The rankings of the products in terms of their gross sales and profitability indexes are given below:

Gross revenues per pallet Ranking based on gross revenues Profitability index Ranking based on profitability index

Traditional Brick Tk.789 3 Tk.74 2

Textured Facing Tk.1,264 1 Tk.71 3

Cinder Block Tk.569 4 Tk.82 1

Roman Brick Tk.836 2 Tk.65 4

To align the salespersonsâ€&#x; incentives with the interests of the company, the salespersons should be compensated based on the profitability index of the products sold or on the total contribution margin generated by the sales. P-13. Bovine Company, a wholesale distributor of DVDs has been experiencing losses for some time, as shown by its most recent income statement below: Tk. Sales 1,500,000 Variable expenses 588,000 Contribution margin 912,000 Fixed expenses 945,000 Net operating loss (33,000) In an effort to isolate the problem, the president has asked for an income statement segmented by geographic market. Accordingly, the Accounting Department has developed the following data: 201


South Central Tk. Tk. 400,000 600,000 52% 30% 240,000 330,000

North Tk. 500,000 40% 200,000

Sales Variable expenses as percentage of sales Traceable fixed expenses Required: (a) Prepare an income statement segmented by geographic market as desired by the president. (b) The company‟s sales manager believes that sales in the central market could be increased by 15%, if advertising were increased by Tk.25,000 each month. Would you recommend the increased advertising? Show computations to support your answer. Solution: (a)

Sales Variable expenses Contribution margin Traceable fixed expenses Segment profit Common fixed expenses Operating profit

Bovine Company Income Statement South Tk. 400,000 208,000 192,000 240,000 (48,000)

Central Tk. 600,000 180,000 420,000 330,000 90,000

North Tk. 500,000 200,000 300,000 200,000 100,000

Total Tk. 1,500,000 588,000 912,000 770,000 142,000 175,000 (33,000)

(b) Increased sales in central market Variable expenses (30%) Incremental contribution Required advertisement costs Incremental gain

Tk.90,000 27,000 63,000 25,000 38,000

Sales manager‟s proposal may be accepted since his prediction on sales volume is correct. Minimum incremental contribution should be Tk.25,000 to cover the expected advertisement costs. So, sales must increase to Tk.35,714. (Tk.25,000 ÷ 70%). Below this level proposal should not be accepted. P-14. Sandia Company currently produces two products, A and B. The company has sufficient floor space to manufacture an additional product with two (C and D) currently under consideration. Only one of the two products can be chosen. The expected annual sales and associated costs for each product are as follows: Product C Product D Tk. Tk. Sales 100,000 125,000 Variable cost as a percentage of sales production 54% 65% Selling and administration expenses 12% 5% Direct fixed expenses 15,000 11,250 202


The common fixed costs are allocated to each product line on the basis of sales revenues. The following income statement for the last yearâ€&#x;s operation is also available: Product A Product B Total Tk. Tk. Tk. Sales 250,000 375,000 6250,000 Less: Variable expenses Production (100,000) (250,000) (350,000) Selling and administration (20,000) (65,000) (85,000) Contribution margin 130,000 60,000 190,000 Less: Direct fixed expenses (10,000) (55,000) (65,000) Segment margin 120,000 5,000 125,000 Less: Common fixed cost (75,000) Net income 50,000 Required: Prepare an income statement that reflects the impact on the firmâ€&#x;s profits on adding product C. Repeat for product D. Which of the two would you recommend adding? Solution:

Sales Variable expenses: Production Selling and administration Contribution margin Direct fixed expenses Segment margin Common fixed cost Net income

Sales Variable expenses: Production Selling and administration Contribution margin Direct fixed expenses Segment margin Common fixed cost Net income

Sandia Company Income Statement Product A Product B Tk. Tk. 250,000 375,000 (100,000) (20,000) 130,000 (10,000) 120,000

Sandia Company Income Statement Product A Product B Tk. Tk. 250,000 375,000 (100,000) (20,000) 130,000 (10,000) 120,000

Product D is preferable on financial consideration. 203

(250,000) (65,000) 60,000 (55,000) 5,000

(250,000) (65,000) 60,000 (55,000) 5,000

Product C Tk. 100,000

Total Tk. 725,000

(54,000) (404,000) (12,000) (97,000) 34,000 224,000 (15,000) (80,000) 19,000 144,000 75,000 69,000

Product D Tk. 125,000

Total Tk. 750,000

(81,250) (431,250) (6,250) (91,250) 37,500 227,500 (11,250) (76,250) 26,250 151,250 75,000 76,250


P-15. Surot Company manufactures a line of products. It has an effective production capacity of 2,00,000 labor hours per year on a single shift. The company has the following budgeted data. (a) Expected demand and selling price per unit are as follows: Product Expected demand Selling price per (Unit) unit (Tk.) A 40,000 215 B 1,00,000 150 C 60,000 220 (b) Standard production costs per unit are as follows: Product Material Labor (Tk.) (Tk.) A 30 50 B 20 30 C 40 40 (c) Variable manufacturing overhead is budgeted at Tk.50 per direct labor hour. Product A, B and C required 1.5, 0.5 and 2.0 direct labor hours respectively. Total fixed manufacturing overhead for the year is budgeted at Tk.19,00,000. Required: (a) Prepare a product sales mix that will maximize the profits of Surot Company for the forthcoming period. (b) Prepare an income statement at such product sales mix. Solution: (a) Schedule that will be useful to management Particulars A Tk. Selling price per unit 215 Less. Variable costs: Materials 30 Labor 50 Variable manufacturing overhead 75 Total variable costs 155 Contribution margin per unit 60 Contribution margin per direct labor hour 40

B Tk. 150

C Tk. 220

20 30 25 75 75 150

40 40 100 180 40 20

If capacity of the machine is the key factor, contribution margin per direct labor hour should be considered. Hence, product should be produced in the sequence: B, A and C.

Product

B A C

DLH per unit 0.5 1.5 2.0

Determination of product sales mix Expected Labor Labor Labor Actual demand hours hours hours left production in units available used units 100,000 200,000 50,000 150,000 100,000 40,000 150,000 60,000 90,000 40,000 60,000 90,000 90,000 45,000 204


(b) Surot Company Income Statement Tk. Contribution margin A (Tk.60 X 40,000 units) B (Tk.75 X 100,000 units) C (Tk.40 X 45,000 units) Total contribution margin Less. Fixed manufacturing overhead Net income

Tk.

24,00,000 75,00,000 18,00,000 1,17,00,000 (19,00,000) 98,00,000

P-16. “In my opinion, we ought to stop making our own drums and accept that outside supplier‟s offer,” said Mr. H. M. Nahiyan, Managing Director of Antilles Refining. “At a price of Tk.18 per drum, we would be paying Tk.5 less than it costs us to manufacture the drums in our own plant. Since we use 60,000 drums a year, which would be an annual cost savings of Tk.300,000.” Antilles Refining‟s present cost to manufacture one drum is given below (based on 60,000 drums per year): Direct materials Tk.10.35 Direct labor 6.00 Variable overhead 1,50 Fixed overhead (Tk.2.80 general company overhead, Tk.1.60 depreciation and Tk.0.75 supervision) 5.15 Total cost per drum Tk.23.00 A decision about whether to make or buy the drums is especially important at this time since the equipment being used to make the drums is completely worn out and must be replaced. The choices facing the company are: Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for Tk.135,000 per year. Alternative 2: Purchase the drums from an outside supplier at Tk.18 per drum. The new equipment would be more efficient than the equipment that Antilles Refining has been using and according to the manufacturer, would reduce direct labor and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost (Tk.45,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment‟s capacity would be 90,000 drums per year. The company‟s total general overhead would be unaffected by this decision. Required: (a) To assist the Managing Director in making decision, prepare an analysis showing the total cost and the cost per drum for each of the two alternatives given above. Assume that 60,000 drums are needed each year. Which course of action would you recommend to the Managing Director? (b) Would your recommendation in (a) above be the same if the company‟s need were: (i) 75,000 drums per year or (ii) 90,000 drums per year? Show computations to support your answer, with costs presented on both a total and a per unit basis. (c) What other factors would you recommend that the company consider before making a decision? 205


Solution: (a) The Tk.2.80 per drum general overhead cost is not relevant to the decision, since this cost will be the same regardless of whether the company decides to make or buy the drums. Also, the present depreciation figure of Tk.1.60 per drum is not a relevant cost, since it represents a sunk cost (in addition to the fact that the old equipment is worn out and must be replaced). The cost of supervision is relevant to the decision, since this cost can be avoided by buying the drums.

Outside supplier‟s price Direct materials Direct labor (Tk.6 X 70%) Variable overhead (Tk.1.50 X 70%) Supervision Equipment rental (Tk.135,000 ÷ 60,000 drums) Total costs Difference in favor of buying

Differential costs Per drum Make Buy Tk.18.00 Tkk.10.35 4.20 1.05 0.75 2.25 Tk.18.60

Total differential costs (60,000 drums) Make Buy Tk.1,080,000 Tk.621,000 252,000 63,000 45,000 135,000

Tk.18.00 Tk.0.60

Tk.1,116,000 Tk.1,080,000 Tk.36,000

Antilles Refining should purchase the drums from an outside supplier. (b) (i) Notice that the unit cost for both supervision and equipment rental decrease with the greater volume since these fixed costs are spread over more units.

Outside supplier‟s price Direct materials Direct labor (Tk.6 X 70%) Variable overhead (Tk.1.50 X 70%) Supervision (Tk.45,000 ÷ 75,000 drums) Equipment rental (Tk.135,000 ÷ 75,000 drums) Total costs Difference

Differential costs Per drum Make Buy Tk.18.00 Tkk.10.35 4.20 1.05

Total differential costs (75,000 drums) Make Buy Tk.1,350,000 Tk.776,250 315,000 78,750

0.60

45,000

1.80

135,000

Tk.18.00

Tk.18.00 Tk.0.00

Tk.1,350,000 Tk.1,350,000 Tk.0

The company would be indifferent between the two alternatives if 75,000 drums were needed each year.

206


(ii) Again, notice that the unit cost for both supervision and equipment rental decrease with the greater volume of units.

Outside supplier‟s price Direct materials Direct labor (Tk.6 X 70%) Variable overhead (Tk.1.50 X 70%) Supervision (Tk.45,000 ÷ 90,000 drums) Equipment rental (Tk.135,000 ÷ 90,000 drums) Total costs Difference in favor of making

Differential costs Per drum Make Buy Tk.18.00 Tkk.10.35 4.20 1.05

Total differential costs (90,000 drums) Make Buy Tk.1,620,000 Tk.931,500 378,000 94,500

0.50

45,000

1.50

135,000

Tk.17.60 Tk.0.40

Tk.18.00

Tk.1,584,000 Tk.1,620,000 Tk.36,000

The company should purchase the new equipment and make the drums if 90,000 units per year are needed. (c) Other factors that the company consider: - Will volume in future years be increasing, or will it remain constant at 60,000 units per year? If volume increases, then renting the new equipment becomes more desirable, as shown in the computations above. - Can quality control be maintained if the drums are purchased from the putside supplier? - Will costs for materials and labor increase in future years, thereby increasing the cost of making the drums? - Will the outside supplier be dependable in meeting shipping schedules? - Can the company begin making the drums again if the supplier proves to be undependable, or are there alternative suppliers? - What is the labor outlook in the supplier‟s industry (i.e., are frequent labor strikes likely)? - If the outside supplier‟s offer is accepted and the need for drums increases in future years, will the supplier have the added capacity to provide more than 60,000 drums per year? P-17. Powertech operates a store of selling spare parts for cargo handing equipments. The store has previously only opened for 6 days per week for 50 working weeks in the year, but Powetech is now considering also opening rest 1 day due to market demand. The sales of the business on Saturday through to Thursday averages at Tk.10,000 per day with average G/P of 70% earned. It has been expected by Powertech that the gross profit percentage earned on a Friday will be 20% points lower than the average earned on the other days in the week. This is because they plan to offer substantial discounts and promotions on a Friday to attract customers. Given the price reduction, Friday sales revenues are expected to be 60% more than the average daily sales revenues for the other days. These Friday sales estimates are 207


for new customers only, with no allowance being made for those customers that may transfer from other days. Powertech buys all of its goods from our supplier. This supplier gives a 5% discount on all purchases if annual spend exceeds one million Taka. It has been agreed to pay time and half to sales assistants that work on Fridays. The normal hourly rate is Tk.20 per an hour. In total five assistants will be needed for the six hours that the store will be open on a Friday. They will also be able to take a half-day off (four hours) during the week. Staffing levels will be allowed to reduce slightly during the week to avoid extra cost being incurred. The staff will have to be supervised by a manager, currently employed by the company and paid an annual salary of Tk.80,000. If the manager works on a Friday, he will take the equivalent time off during the week when the assistant manager is available to cover for him at no extra cost. He will also be paid a bonus of 1% of the extra sales generated on the Friday business. The store will have to be lit at cost of Tk.30 per hour and heated at a cost of Tk.45 per hour. The heating will come on two hours before the store opens in the 25 „Winter‟ weeks to make sure it is warm enough for customers to come in at opening time. The store is not heated in the other weeks. The rent of the store amounts to Tk.4,20,000 annum. Required: (a) Calculate whether the Friday opening incremental revenue exceeds the incremental costs over a year and on this basis comment on whether Friday opening is justifiable (ignore inventory movements). (b) Discuss whether the manager‟s pay deal is likely to motivate him or not. (c) Discuss whether offering substantial price discounts and promotions on Friday is a good business move. Solution: (a) The decision to open on Friday is to be based on incremental revenue and incremental costs. Incremental sales revenue (W-1) Incremental costs: Cost of sales (W-2) Staff cost (W-3) Lighting cost (W-4) Heating cost (W-5) Manager‟s bonus (W-6) Net incremental revenue

Tk.800,000 Tk.335,000 45,000 9,000 9,000 8,000

(406,000) Tk.394,000

As incremental revenue exceeds cost, it is therefore financially justifiable to open on Friday.

208


(b) Manager‟s reward: Time off: This appears far from generous. Other staff are being paid time and a half and yet the manager does not appears to have his option and also is only given time off in lieu at normal rates. Some managers may want their time back so as to spend time with friends and family; other may want the cash to spend. So some flexibility would have been sensible if the manager is to be motivated properly. Bonus: The bonus can be calculated at Tk.8,000 yearly on a day worked basis, this is Tk.160 per day. This is less than that being paid to normal staff which is time and a half (Tk.180 per day). It is unlikely to be enough to keep the qualified manager happy. The bonus is dependent on the level of new sales and so there is a risk involved for the managers. Generally we know that higher risk for lower returns is far from motivating. (c) Discounts and promotions: There are various issues here: Changing buying patterns – It is possible that customer might delay a purchase 1 day or 2 in order to buy on Friday. This would cost the total business since the margin earned on Friday is predicted to be 20% points lower than on other days. Complaints – Customers that have already bought an item on another day might complain when they see the same product on sale for much less when they come back in for something else on a Friday. Businesses need to be strong in this regard in that they have to retain control over their pricing policy. Quality – On the price of an item can say something about its quality, low prices tend to suggest poor quality and vice versa. Powertech should be careful so as not to suggest that low prices do not damage the reputation of the business as regards quality. Workings: 1. Incremental revenue: Day Average Friday (+60%) Annually (50 weeks) Current results (300days) Net results

Sales revenue (Tk.) 10,000 16,000 800,000 3,000,000 3,800,000

Gross profit (%) 70% 50% 70% 65.8%

Gross profit (Tk.)

Cost of sales (Tk.)

8,000 400,000 2,100,000

8,000 400,000

2. Cost of sales: Extra purchasing from Friday trading (Tk.800,000 – Tk.400,000) = Tk.400,000 Current annual purchasing (Tk.18,000 X 50) = Tk.900,000 New annual purchasing (Tk.400,000 + Tk.900,000) X 0.95 = Tk.1,235,000 Incremental cost of sales (Tk.1,235,000 – Tk.900,000) = Tk.335,000 209

2,500,000


3. Staff cost: On Friday 5 staff X 6 hours X 20p per hour X 1.5 = Tk.900 per day Annual cost (Tk.900 X 50 days) = Tk.45,000 4. Lighting cost (6 hours X Tk.30 per hour X 50 days) = Tk.9,000 5. Heating cost (8 hours X Tk.45 per hour X 25 days) = Tk.9,000 6. Managerâ€&#x;s bonus: This is based on current incremental revenue (Tk.800,000 X 1%) = Tk.8,000

Contact us to collect exercises solution. Helpline: 01711137039

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EXERCISES E-1. Champ-kid‟s (CK) is a shop for various branded baby items. It seems that demand of a particular fast moving baby food item “Growth Plus” is increasing rapidly. “Growth Plus” supplied in two different cartons, small size for 600 gm and large size for 1200 gm. From existing market, it is identified that small size for 600 gm can fulfill the demand of the 90% of the customers and CK wants to keep small size in the shop as they are in shortage of the storage facility. CK considering three different showcase for the product to store and display in the shop. The capacity is 100 cartons for the small showcase, 150 for the medium showcase and 200 for the large showcase. CK is unable to make a decision, which showcase to buy for the shop. Demand for Growth Plus varies and can be either 130 or 180 cartons per period, with the probability of the higher demand figure being 0.55. The sale price per carton is Tk.25,000/- and the variable cost Tk.19,000/- per carton for all showcase sizes subject to the fact that is the capacity of the showcase is greater than the demand for cartons in a period then the variable cost will be lower by 5% to allow for the fact that the showcase will be partly and other products will be displayed for sales and will be able to generate additional margins for the shop. CK is concerned that is the demand for cartons exceeds the capacity of the showcase then customers will have to be turned away. CK estimates that in this case goodwill of Tk.80,000/- would be charged against profits per period to allow for lost future sales regardless of the number of customers that are turned away. Depreciation charged would be Tk.120,000/- per period for the small, Tk.180,000/- for the medium and Tk.280,000/for the large showcase. CK has in the past been very aggressive in its decision-making, pressing ahead with rapid growth strategies. However, its managers have recently grown more cautious as the business has become more competitive. Required: (i) Prepare a profits table showing the SIX possible profit figures per period. (You can use a payoff matrix) (ii) Describe THREE methods other than maximax, maximin & minimax, which a businesses can use to analyze and assess the risk that exists in its decision-making. CMA Adapted – December 2016 E-2. X Ltd. manufactures three components used in the finished product. The component workshop is currently unable to meet the demand for components and the possibility of sub-contracting part of the requirement is being investigated on the basis of the following data: Component A B C Variable cost of production 3.00 4.00 7.00 Fixed cost of production 1.00 2.00 4.00 Outside purchase price 2.50 6.00 13.00 Machine hours per unit 1 0.5 2 Labour hours per unit 2 2 4 211


Required: (i) To decide which component should be bought out if the company is operating at full capacity. (ii) To decide which component should be bought out if production is limited to 4,000 machine hours per week. (iii) To decide which component should be bought out if production is limited to 4,000 labor hours per week. CMA Adapted – June 2016 E-3. PHP Industries manufactures and sells four products A, B, C and D as per the details given below: A B C D Selling price per unit ($) 60 80 100 120 Variable cost of production per unit ($): Direct materials 16 20 36 40 Direct labor 20 24 32 36 Variable overheads (Production) 50% of direct labor cost Variable overheads (Selling and distribution) 10% of sales value Machine hours required for each unit 0.75 1.75 .075 2 Fixed costs per annum: Production $300,000 Administration 200,000 Selling and distribution 250,000 Weekly sales are subject to a minimum of 400 units committed and a maximum of 2,000 units for each of the products. The company operates ts factory for 50 weeks a year. The total machine hour available per week is only 3,000 hours. Required: (i) Analyze the given data and suggest the production plan for maximum profit. (ii) Compute profit to be earned according to above plan. (iii) An export order for supply of 2,500 units of „A‟ every month for the next three years has been received. Acceptance of the order will require augmentation of the machine capacity and this will increase the annual fixed costs (production) by $150,000. Variable selling and distribution cost will be $12 per unit. Domestic sales will not be affected and no other costs would be incurred. What minimum price should the firm quote, if it wants to get 10% margin on sales? CMA Adapted – June 2016 E-4. Hussein M.N. Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin. After considerable research, a winter products line has been developed. However, Hussein‟s president has decided to introduce only one of the new products for this coming winter. If the products is a success, further expansion in future years will be initiated. The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for Tk.8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be 212


incurred to produce the product. However, a Tk.90,000 charge for fixed manufacturing overhead will be absorbed by the product under the companyâ€&#x;s absorption costing system. Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box: Direct material Direct labor Manufacturing overhead Total cost

Tk.3.60 2.00 1.40 Tk.7.00

The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Hussein has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be Tk.1.35 per box of 24 tubes. If Hussein Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 25%. Required: (i) Should Hussein Industries make or buy the tubes? Show calculations to support your answer. (ii) What would be the maximum purchase price acceptable to Hussein Industries? Explain. (iii) Instead of sales of 100,00 boxes, revised estimates show a sales volume of 120,0000 boxes. At this new volume, additional equipment must be acquired to manufacture the tubes at an annual rental of Tk.40,000. Assuming that the outside supplier will not accept an order for less than 100,000 boxes, should Hussein Industries make or buy the tubes? Show computations to support your answer. (iv) Refer to the data in (iii) above. Assume that the outside supplier will accept an order of any size for the tubes at Tk.1.35 per box. How, if at all, would this change your answer? Show computations. (v) What qualitative factors should Hussein Industries consider in determining whether they should make or buy the tubes? CMA Adapted – August 2015 E-5. XYZ company has asked your manager in determining the most profitable sales and production mix of its products. The company manufactures a line of toys. The sales department has provided you the following budgeted data: Toy A B C D E

Estimated demand (In unit) 60,000.00 1,00,000.00 50,000.00 45,000.00 2,20,000.00

Selling price per toy (In Tk.) 145.00 79.00 166.00 252.00 60.00

The cost accountant has developed the following additional data from the accounting files: (1) Standard direct production cost per unit are as follows: 213


Product (Toy) A B C D E

Material (In Tk.) 41.00 21.00 55.00 100.00 19.00

Labor (In Tk.) 50.00 25.00 60.00 80.00 15.00

(2) The standard wage rate of Tk.100.00 per hour is expected to continue unchanged throughout the year. The plant has an effective production capacity of 1,51,000 labor hours per year on a single shift. The current equipment can be used to produce any and all of the products (toys). (3) Variable manufacturing overhead is budgeted at Tk.30.00 per direct labor hour. Total fixed manufacturing overhead for the year is planned at Tk.72,00,000.00 Required: (i) Prepare a schedule that will be most useful to management in planning the product mix. Determine the amount of net income at such a product mmix. (ii) Is the present effective capacity on a single shift adequate to meet the estimated sales demand? If not, what will be the optimal product mix to keep production within the limits of a single shift? CMA Adapted – August 2015 E-6. Power Resources Company Ltd. normally produces and sells 30,000 unit of RG-6 each month, RG-6 is a small electrical relay used in the automotive industry as a component part in various products. The selling price is Tk.24 per unit, variable costs are Tk.16 per unit, fixed manufacturing overhead costs total Tk.1,50,000 per month and fixed selling costs total Tk.30,000 per month. Employment-contract strikes in the companies that purchase the bulk of RG-6 units have caused Power Resources company‟s sales estimates that the strikes will last for about two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, however, Power Resources company is thinking about closing down its own plant during the two months that the strikes are on. If Power Resources company does close down its plant, it is estimated that fixed manufacturing overhead costs can be reduced to Tk.1,00,000 per month and fixed selling costs can be reduced by 10%. Start-up costs at the end of the shutdown period would total Tk.18,000. Since Power Resources company uses just-in-time (JIT) production methods, no inventories are on hand. Requires: (i) Assuming that the strikes continue for two months, as estimated, would you recommended that Power Resources Company close its own plant? Show computation. (ii) At what level of sales (in units) for the two months period should Power Resources Company be indifferent between closing the plant or keeping it open? Show computations. CMA Adapted – April 2015 E-7. Isamoti Company manufactures three products: A, B, and C. The selling price, variable costs, and contribution margin for one unit of each product follow: 214


Selling price Less: variable expenses: Direct materials Other variable expenses Total variable expenses Contribution margin Contribution margin ratio

A Tk.180

Product B Tk.270

24 102 126 54 30%

72 90 162 108 40%

C Tk.240 32 148 180 60 25%

The same raw material is used in all three products. Isamoti Company has only 5,000 pounds of raw materials on hand and will not be able to obtain any more of it for several weeks due to a strike in its supplierâ€&#x;s plant. Management is trying to decide which product(s) to concentrate on next week in filling its backlog of orders. The material costs Tk.8 per pound. Required: (i) Compute the amount of contribution margin that will be obtained per pound of material used in each product. (ii) Which orders would you recommended that the company work on next week-the orders for product A, product B, or product C? Show computations. (iii) A foreign supplier could furnish Isamoti with additional stocks of the raw material at a substantial premium over the usual price. If there is unfilled demand for all three products, what is the highest price that Isamoti Company should be willing to pay for an additional pound of materials? Explain. CMA Adapted – April 2015 E-8. PRAN Company Ltd. sells three products in a foreign market and a domestic market income statement for the first month of the current year shows the following results: Sales Tk.1,30,00,000 Cost of goods sold (1,01,00,000) Gross profit 29,00,000 Selling expense 10,50,000 Administrative expenses 7,20,000 (17,70,000) Net income 1,13,000 Data regarding the two markets and three products are given below: Products A B Sales: Domestic 40,00,000 30,00,000 Foreign 10,00,000 10,00,000 Total sales 50,00,000 50,00,000 Variable production costs (% of sales) Variable selling costs (% of sales)

60% 3%

70% 2%

C 30,00,000 10,00,000 50,00,000 60% 2%

Product A is made in a single factory that incurs fixed costs (included in cost of goods sold) of Tk.4,80,000 per month. Products B and C are made in a single factory and require the same machinery. The monthly fixed production costs at that factory are Tk.14,30,000. 215


Fixed selling expenses are joint to the three products, but Tk.3,60,000 is separable with respect to the domestic market and Tk.3,80,000 to the foreign market. All administrative expenses are fixed. About Tk.2,50,000 is traceable to the foreign market Tk.3,50,000 to the domestic market. Required: (1) Prepare performance reports for the domestic market and foreign market (Assume that the firm has separate managers responsible for each market.) (2) Prepare performance reports for the three products (Assume that the firm has separate managers responsible for each product.) CMA Adapted – December 2014 E-9. Tuntun Ltd. is a distribution company which buys product in bulk from manufacturers, repackages the product into smaller packs and then sell the packs to retail customers. Tuntunâ€&#x;s Customers vary in size and consequently the size and frequency of their orders also varies. Some customers order large quantities each time they place an order. Other Customers order only a few packs each time. The current accounting system of Tuntun produces very basic management information that reports only the overall company profit. Tuntun is therefore unware of the costs of servicing individual customers. However the company has now decided to investigate the use of Direct Customer Profitability Analysis. Tuntun would like to see the results from a small sample of customers before it decides whether to fully introduce Direct Customer Profitability Analysis. The information for two customers and for the whole company for the year (2014) is as follows: Customer (X) Customer (Y) Total Factory Contribution (Tk.000) 75 40.5 450 Number of: Packs sold (000) 50 27 300 Sales visit to customers 24 12 200 Orders placed by customers 75 20 700 Normal deliveries to customers 45 15 240 Urgent deliveries to customers 5 0 30 Activity costs: Sales visit to customers Progressing orders placed by customers Normal deliveries to customers Urgent deliveries to customers

Tk. (000) 50 70 120 60

Required: (i) Prepare a Direct Customer Profitability Analysis for each of the two Customers. (ii) Explain how Tuntun Ltd. could use Direct Customer Profitability Analysis to increase its profit. CMA Adapted – December 2014 216


E-10. Keya & Kiran Company makes electricity driven scooters. At present wheels and tyres are bought from external suppliers but all other parts are manufactured in – house. The scooters have a strong reputation due mainly to innovative designs, special power units that can be recharged at homes and seats that enable easy access for a wide range of customers. The Company also sells power units to other firms. Current monthly costs are as follows: Costs Seating Department Power unit Department Direct materials Tk. 9,300 Tk. 4,140 Direct labor 12,600 9,450 Apportioned overheads 26,700 17,200 Production 60 units 90 units Note: The power unit department currently produces 90 units a month – 60 being used in it‟s own scooters, and 30 being sold externally at Tk. 376 each. A new order has been won to supply an additional 10scooters per month. However, the directors are considering how best to meet the additional demand:  Sufficient capacity exists for the company to increase its monthly production to 70 scooters, except that making an extra 10 seating assemblies would require reallocation of labor and other resources from the power unit to the seating department. This would cut power unit output by 20 units per month.  The alternative course would be to buy 10 seating assemblies from an outside supplier and fit the 10 power units from the present production of 90 units. The cheapest quote for seating assemblies is Tk. 610 per assembly. Required: (i) Based on the figures given, show whether Keya & Kiran Company should make or buy the extra seats. (ii) Discuss what other factors should be considered before a final decision is taken to make or to buy the extra seats. (iii) Comment on the relevance of the apportioned overhead cost figures to your recommendation. CMA Adapted – August 2014 E-11. Reia-Piea owns an ice cream stand that she operates during the summer months in south zone Chittagong. Her store caters primarily to tourists passing through town on their way to south zone National Park. Reia-Piea is unsure of how she should price her ice cream cones and has experimented with two prices in successive weeks during the busy August season. The number of people who entered the store was roughly the same in the two weeks. During the first week, she priced the cones at Tk.189.00 and 15,000 cones were sold. During the second week, she priced the cones at Tk.149.00 and 23,400 cones were sold. The variable cost of a cone is Tk.43.00 and consists solely of the costs of the ice cream and of the cone itself. The fixed expenses of the ice cream stand are Tk.6,75,000 per week. Required: (i) Did Reia-Piea make more money selling the cones for Tk.189.00 or for Tk.149.00? (ii) Estimate the price elasticity of demand for the ice cream cones. (iii) Estimate the profit-maximizing price for ice cream cones. CMA Adapted – August 2014 217


E-12. The New Age Industries produces three products. The budgeted operations of coming year are given as follows: Products Sales Variable costs Profit contribution Avoidable fixed costs Profit contribution after avoidable fixed cost Investments in receivables and inventories

A (Tk.) 9,00,000 4,00,000 5,00,000 2,00,000 3,00,000 7,00,000

B (Tk.) 6,40,000 3,60,000 2,80,000 1,00,000 1,80,000 6,00,000

C (TK.) 3,60,000 2,40,000 1,20,000 90,000 30,000 5,00,000

Unallocated joint costs total Tk.2,50,000. The firm is considering a proposal to drop product line C. If the firm does so, it can recover the investment in receivables and inventories related to the line and pay off debts of Tk.5,00,000 that bears 15% interest. Required: Determine whether the firm should drop the product line or not. CMA Adapted – August 2014 E-13. You are management accountant at health Pharmaceuticals Ltd. The company is under intense competition. Mr. President of the company has asked you to evaluate whether the company should continue to manufacture Z-500 mg or import it from outside the country. An agent has submitted a price to supply 30,000 units of Z-500 mg units to the company will need for the next month of 2014 at price 20.50 each. The following information regarding cost to manufacture 30,000 units of Z-500 mg in January 2014 is given by the plant Manager: Particulars of Costs Direct Materials Direct labour Plant space rent Equipment on leasing Other manufacturing overhead Total manufacturing cost

Cost for 30,000 Units in January 2014 Total Unit costs 1,95,000 6.50 1,20,000 4.00 84,000 2.80 36,000 1.20 2,25,000 7.50 6,60,000 22.00

Additional information: 1) Variable cost per unit will be the same per unit as shown in January 2014. 2) The plant rental and equipment lease are annual contracts are going to be expensive to remove out of. The plant Manager estimates that it will cost Tk.10,000 to terminate the rental contracts and Tk.5,000.00 to terminate the equipment contracts. 3) 40% of the other manufacturing overhead is variable, proportionate to the direct manufacturing labour cost. The fixed component of other manufacturing overhead is expected to remain the same whether Z-500 mg is manufacture or import from outside. 4) The company has just in-time policy which means that the inventory is negligible. An independent analysis of the competitive and other economic data the following factors are to be considered: 218


i) Price of direct materials are likely to be higher by 8% compared to previous month. ii) Direct manufacturing labour rate are likely to higher by 5%. iii) The plant rental contract can in fact be terminated by paying Tk.10,000 but will not have any need for this space if Z-500 mg is outsourced. iv) The equipment lease can be terminated by paying Tk.3,000. But plant manager argues that you are ignoring the amazing continuous improvement that is occurring at the plant and that increase in direct materials prices and direct manufacturing labour rates assumed by you will not occur. Required: 1. On the basis of the materials and labour cost estimates originally complied with the plant manager, should you recommend the Z-500 mg be produced at the company plant or imported from outside? 2. On the basis of the independent analysis should you recommended that Z-500 mg be produced or import? Show your computation. CMA Adapted – April 2014 E-14. Abree Pharmaceutical Industries Ltd. produces Tablets in two department: Mixing and Tablet Making. The following are the additional information: Capacity per hour Monthly capacity (2,00 hours are available in each department) Fixed operating cost (Taka) (Excluding direct materials) Monthly production

Mixing 1,500 grms

Tablet Making 2,000 tables

30,00,000 grms 1,60,000

40,00,000 tablets 3,90,000

20,00,000 grms

39,00,000 tablets

Each table contains 0.5 grm of direct materials. The mixing Department makes 20,00,000 grms of direct materials mixture because the Tablet Making Department has only enough capacity to produces 40,00,000 tables. All direct materials cost are incurred in the Mixing Department. Arbee incurs Tk.15,60,000 direct material costs. The Table Making Department manufactures only 39,00,000 tables from the 20,00,000 grms of mixure processed, 2.5% of the direct materials mixture is lost in the Table making process. Each table sells for Tk.1.00. All costs other than direct materials are fixed costs. Required: 1) An outside contractor makes the following offer: If Arbee will supply the contractor with 1,00,000 grms of mixture the contractor will manufacture 1,95,000 tablets at Tk.0.12 per tablet. 2) Suppose that Arbee has lost 1,00,000 grms of mixture in its Mixing Department. These losses can be reduced to zero, if the company is willing to spend Tk.90,000 per month in quality improvement method. Should Arbee adopt the quality improvement method? Show your computation. 3) What are the benefit of improving quality in the Mixing Department compared with improving quality in the tablet-Making Department. CMA Adapted – April 2014

219


E-15. The National Export Company Ltd. is operating right now at 75% level of activity. The company produces and sells two products: Product–A and Product–B. The chief cost accountant prepares the following cost sheet of these two products.

Units produced & sold (units) Direct materials Direct labour Factory overhead (40% fixed) Selling & distribution and administrative (60% fixed) Total cost per unit

Product – A 6,000 Tk. 20.00 40.00 50.00 80.00 19000

Selling price per unit

230.00

Product – B 4,000 Tk. 40.00 40.00 30.00 50.00 160.00 190.00

Other information: (1) Factory overheads are absorbed on the basis of machine hour, which is the limiting factor. The machine hour rate is Tk. 20 per hour. (2) The company receives an offer from Canada for the purchase of product A at a price of Tk. 175.00 per unit. (3) The company has also another offer from the USA for the purchase of product B at price of Tk. 155.00 per unit. (4) In both the cases a special packing charge of Tk. 5.00 per unit has to be borne by the company. (5) The company can accept either of the two export orders and in either case the company can supply such quantities that may be produced by utilizing the balance 25% of its capacity. Required: (i) A profitability statement showing economics of the two export orders giving your recommendation as to which proposal should be accepted. (ii) A statement showing the overall profitability of the company after incorporating the export recommendation by you. Assume that export offer may be of any number of units and the company wants to maximize its net income. (iii) “A customer profitability profile highlights those customers who should be dropped to improve profitability.” Do you agree? Explain. CMA Adapted – December 2013 E-16. Ayman Household Manufacturing (AHM) manufactures and sells a small range of kitchen equipment. Specifically the product range contains a dish cleaner (DC), a dish dryer (DD) and a dish cabinet (DCB). The DCB is of a rather old design and has for sometimes generated negative contribution. It is widely expected that in one year‟s time the market for this design of DCB will cease, as people switch to a more modern cabinet, which is attractive to look and has high durability. AHM is trying to decide whether or not to cease the production of DCB now or in 12 months‟ time when the new type of cabinet will be ready. Following information has been provided for your decision. 220


(a)

(b)

(c)

(d)

(e)

(f)

DC DD DCB Selling price per unit Tk. 200 Tk. 350 Tk. 80 Material cost per unit 70 100 50 Labour cost per unit 50 80 40 Contribution per unit Tk. 80 Tk. 170 Tk. (10) Annual sales (units) 5000 units 6000 units 1200 units It is thought that some of the customers that buy a DCB also buy a DC and DD. It is estimated that 5% of the sales of DC and DD will be lost if the DCB ceases to be produced. All the direct Labor force currently working on the DCB will be made redundant immediately if DCB is ceased now. This would cost Tk. 6,000 in redundancy payments. If AHM waited for 12 months the existing labor force would be retained and retrained at a cost of Tk. 3,500 to enable them to produce the new cabinet product. Recruitment and training cost of labor in 12 monthsâ€&#x; time would be Tk. 1,200 in the event that redundancy takes place now. AHM operates a JIT policy and so all material costs would be saved on the DCB for 12 months if DCB production ceases now. Equally the material cost relating to the lost sales on the DC and DD would also be saved. However, the material supplier has a volume based discount scheme in place as follows: Annual Expenditure (Tk.) Discount 0 6,00,000 0% 6,00,001 8,00,000 1% 8,00,001 9,00,000 2% 9,00,001 9,60,000 3% 9,60,000 and above 5% AHM uses this supplier for all its materials for all the products it manufactures. The figures given above in the cost per unit table for material cost per unit are net of any discount AHM already qualified for. The space in the factory currently used for the DCB will be sublet for 12 months on a short-term lease contract if production of DCB stops now. The income from that contract will be Tk. 12,000. The supervisor (currently classed as an overhead) supervises the production of all three products spending approximately 20% of his time on the DCB production. He would continue to be fully employed if the DCB ceases to be produced now.

Required: (i) Calculate whether or not it is worthwhile ceasing to produce the DCB now rather than waiting 12 months (Ignore time value of money). (ii) Explain two pricing strategies that could be used to improve the financial position of the business in the next 12 months assuming that the DCB continues to be made in that period. (iii) Briefly describe three issues that AHM should consider if it decided to outsource the manufacture of one of its future products. CMA Adapted – December 2013

221


E-17. The annual flexible budget of Tesco Lotus Ltd is as follows: Capacity 40% 60% Costs Tk. Tk. Direct labor 16,000 24,000 Direct materials 12,000 18,000 Production overhead 11,400 12,600 Administrative costs 5,800 6,200 Selling and Distribution cost 6,200 6,800 51,400 67,600

80% Tk. 32,000 24,000 13.800 6,600 7,400 83,800

100% Tk. 40,000 30,000 15,000 7,000 8,000 1,00,000

Owning to trading difficulties, the company is operating at 50% capacity. Selling prices have had to be lowered to what the director maintain in an uneconomical level and they are considering whether or not their single factory should be closed down until trade recession has passed. A market research consultant has advised that in about 12 months‟ time there is every indication that sales will increase to about 75% of normal capacity and that the revenue to be produced in the second year will amount to Taka 90,000. The present revenue from sales at 50% capacity would amount to only Tk.49,500 for a complete year. If the directors decided to close down the factory for a year, it is estimated that: (i) The present fixed cost would be reduced to Tk.11,000 p.a. (ii) Closing down cost would amount to Tk.7,500. (iii) Necessary maintenance at plat would cost Tk.1,000 p.a. (iv) On reopening the factory, the cost of overhauling plant, training and engagement of new personnel would amount to Tk.4,000. Required: Prepare a statement for the directors presenting the information in such a way as to indicate whether or not it is desirable to close the factory. CMA Adapted – August 2013 E-18. The management of Baker Company is considering the elimination of an unprofitable product. Data for its major products are as follows:

Sales Manufacturing Costs Fixed Operating expenses Income Variable cost ratio Allocated fixed ratio

Snap $4,000 2,800 800 $400 40% $200

Crackle $2,000 1,200 600 $200 30% $200

Pop $1,000 600 800 $(400) 50% $200

Allocated fixed costs would not be affected by a decision to drop a product. However, 50% of fixed costs (both manufacturing and operating) identified with a product would be dropped if the product were eliminated. Prepare an analysis to see whether pops should be eliminated. CMA Adapted – August 2013 222


E-19. Sommers Ltd. a variety of industrial valves and pipe fittings that are sold to customers. Currently, the company is operating at about 70 percent of capacity and is earning a satisfactory return on investment. Management have been approached by Glasgow industries Ltd of Scotland with an offer to buy 120,000 units of pressure value. Glasgow industries manufactures a valve that is almost identical to the pressure value produced by Sommers; however, a fire in Glasgow Industries‟ valve plant has shut down its manufacturing operations. Glasgow needs the 120,000 valves over the next four months to meet commitments to its regular customers. Glasgow is prepared to pay $19 each for the valves. The cost of the pressure valve produced by Sommers, which is based on current attainable standards, is $20, calculated as follows: Direct material Direct Labour Manufacturing overhead Product cost

$5,00 6.00 9.00 $20.00

Manufacturing overhead is applied to production at the rate of $18 per standard direct labour hour. This overhead rate is made up of the following components: Variable manufacturing overhead Fixed manufacturing overhead (traceable) Fixed manufacturing overhead (allocated) Applied manufacturing overhead rate

$6.00 8.00 4.00 $18.00

Additional cost incurred in connection with sales of the pressure valve includes sales commissions of 5 percent of sales, and freight expense of $1 per unit. However, the company does not pay sales commissions on special orders that come directly to management. In determining selling prices, Sommer4s adds a 40 percent mark-up to total product cost. This provides a $28 suggested selling price for the pressure valve. The Marketing Department, however, has set the current selling price at $27 in order to maintain market share. Production management believe that they can handle the Glasgow Industries order without disrupting the department‟s scheduled production. The order would, however, required additional fixed factory overhead of $12000 per month in the form of supervision and clerical costs. If management accept the order, 30000 pressure valve will manufactured and shipped to Glasgow Industries each month for the next four months. Glasgow‟s management have agreed to pay the shipping charges for the valve. Required: a. Determine how many direct labour hours would be required each month to fill the Glasgow Industries order. b. Prepare an analysis showing the impact of accepting the Glasgow Industries order. c. Calculate the minimum unit price that management at Sommers could accept for the Glasgow Industries order without reducing net profit. d. Identify the factors, other than price, that Sommers Ltd. should consider before accepting the Glasgow Industries over. CMA Adapted – April 2013 E-20. AB Ltd. manufactures a picnic table which has three components X, Y and Z, one of each being required for each table. The company is working to its full machine capacity of 28,000 hours per period and the machinery used is capable of making all the components. 223


The tables are made in batches of 20 and data relating to current production are: Components Machine hours Variable costs Fixed costs Table costs X 6 Tk.15 Tk.6 Tk.21 Y 10 18 7 25 Z 12 18 18 36 Assembly 32 13 45 Total Cost 83 44 127 Profit 33 Selling price 150 Over the next budget period the machine capacity cannot be increased although the assembly capacity can be increased as required. The budget for the next period is being prepared. Because sales are buoyant, the purchase of one of the components is being considered and the following quotation has been received: Batch of 20 Component Price X Tk.22 Y 28 Z 32 The company has decided that only one component will be bought from outside in one period. The sales director thinks that he could sell at least 50% more tables than at present and probably 75% more provided that the production capacity was available. You are required to: (i) Recommend which component should be bought from outside if production is increased by 50% and how many components should be bought. (ii) Recommend which component should be bought from outside if production is increased by 75% and how many components should be bought. CMA Adapted – December 2012 E-21. V Ltd. Produces two products P and Q. The draft budget for the next month is as under: P Q Budgeted production and sales (unit) 40,000 80,000 Selling price Tk./unit Tk.25.00 Tk.50.00 Total Costs Tk./unit Tk.20.00 Tk.40.00 Machine hours/unit 2 1 Maximum sales potential (unit) 60,000 100,000 The fixed expenses are estimated at Tk.9,60,000 per month. The company absorbs fixed overheads on the basis of machine hours which are fully utilized by the budgeted production and cannot be further increased when the budget was discussed. The managing Director stated that the product mix should be altered to yield optimum profit. The Marketing Director suggested that he could introduce a new Product C, each unit of which takes 1.5 machine hours. However, a processing vat involving a capital outlay of Tk.2,00,000 is to be installed for processing C. The additional fixed overhead relating to the processing vat was estimated at Tk.60,000 per month. The variable cost of product c was estimated at Tk.21 per unit. 224


Required: (i) Calculate the profit as per draft budget for the next month. (ii) Calculate the profit revising the product mix on the basis of data given on P and Q to yield optimum profit. (iii) The company decides to discontinue, either product P or Q whichever is giving lower profit and proposes to substitute Product C installed. Fix the selling price of product C in such a way as to yield 15% return on additional capital employed besides maintaining the same overall profit as envisaged in (ii) above. CMA Adapted – December 2012 E-22. Global Airlines is considering offering Business Class service on its transpacific routes. The problem Global faces is that it wants the Business Class service to provide an equivalent return that it obtains from its Economy service. The Business Class fare must be set in such a way that it will provide the same margin per seat as the Economy Class fare. Management has some questions as to the appropriate way to assure that this objective will be met. The published Economy Class fare is Tk. 80,000 one way; however, as noted by the revenue accounting manager, discount fares result in an average Economy Class fare of Tk. 50,000 one way. Business Class service would incur a meal cost estimated at Tk. 4,500 per passenger, whereas the Economy Class meal service cost is Tk. 2,500 per passenger. For the space used for each seat in Business Class, it would be possible to fit in 1.5 Economy Class seats. Baggage handling, reservations, and similar incidental costs are estimate at Tk. 1,000 per passenger for the variable portion of those costs for either class. Fixed costs per flight (crew salaries, fuel, landing fees, etc.) are allocated Tk. 27,500 per passenger for either class. What fare for Business Class meets management‟s objectives? CMA Adapted – December 2012 E-23. United Company Ltd. produces three products P, Q and R. Data concerning the three products are as follows: Product P Q R Selling Price per unit Direct Materials per unit Other Variable Expenses per unit

Tk.120 Tk.32 Tk.40

Tk.96 Tk.20 Tk.52

Tk.110 Tk.12 Tk.65

Demand for the company‟s products is very strong, with far more orders each month than the company has raw materials available to produce. The material costs Tk.4 per pound with a maximum of 5,000 pounds available each month. Required: Which orders would you advise the company to accept first……..for P, Q or R? Which orders second and third? CMA Adapted – December 2012 225


E-24. Dhaka Company Ltd. produces several products from processing 1 ton of clypton, a rare mineral. Material and processing costs total Tk. 60,000 per ton, one-fourth of which is allocated to Product X. Seven thousand units of Product X are produced from each ton of clypton. The units can either be sold at the split-off point for Tk. 8.55 each, or processed further at a total cost of Tk. 25,380 and then sold for Tk. 12 each. Required: Should Product X be processed further or sold at the split-off point? To earn an additional income of Tk. 11,510, what should the selling price per unit for Product X after further processing? CMA Adapted – December 2012 E-25. Right-Tyres Ltd. has three depots selling car tyres. The depots are based in N, L and M cities. The average selling price per tyre is Tk.25. Budgets have been produced for the forthcoming period as follows (Tk.): N L Sales 2,000,000 1,500,000 Costs: Purchase price of tyres 1,200,000 900,000 Wages and salaries 250,000 220,000 Overheads 450,000 430,000 Total cost 1,900,000 1,550,000

M 2,500,000 See below 358,000 600,000 See below

The average purchase price per tyre charged by suppliers is the same for both the N and L depots. However, due to higher volume of tyres purchased by the M depot, the M depot benefits from a 20% discount compared to the price charged to the N and L depots. The management of Right-Tyres Ltd. believes that some of the overheads included in the above budgets would not be incurred if the decision was taken to close any of the depots. At recent board meeting, doubt was cast over the future of the L depot given its budgeted loss of Tk.50,000. The percentages of overheads which are variable costs and would not be incurred if a depot were to be closed differs with each depot and are as follows: Depot % N 25 L 15 M 20 If a depot were to be closed it is not expected that there would be any major consequences upon the sales volumes achieved at the remaining depots due to the geographical distances between the depots. Required: (i) Discuss whether the L depot should be closed purely on the basis of financial considerations. (ii) Assuming that 80% of wages and salaries at each depot are variable costs, calculate the number of tyres that must be sold by the whole company in order to break-even. (For this requirement, assume that the L depot will be kept open and that sales will be made at the depots in the ratio used in the original budget.) 226


(iii) Discuss the key non-financial factors that should be considered when making a decision to close part of a business such as the L depot. CMA Adapted – August 2012 E-26. Staly Company has two wholly owned Bangladesh-based subsidiaries. One of these subsidiaries, B Ltd. manufactures plastic toys which it sells to toy retailers. B Ltd. is about to launch a new product but is unsure what price to charge. A firm of consultants has estimated the level of demand at several different prices. This information is as follows: Price (Tk.) 5 10 15 20 25 30 35 40 Level of demand (‟000 of units) 200 180 160 135 120 100 75 50 The cost of manufacturing the new toy has been estimated as follows: Particulars of cost Taka per unit Direct Materials 2.00 Direct Labor 1.50 Variable overheads 2.50 Fixed costs associated with manufacturing the new toy are expected to be Tk. 400,000 per annum. However, if production and sales exceed 150,000 units fixed costs are expected to increase by Tk. 50,000. The second subsidiary, E Ltd. Assembles desktop computers using components sourced from suppliers of keyboards, microchips, monitors, speakers and so on. It sells these computers under its own brand name through 150 of its own outlets in major shopping centers throughout Dhaka. It is to commence selling a new computer aimed at students. The management of E Ltd. believes that the price and marginal revenue equations are as follows: Price equation: P = 20,000 – 0.01Q, where P is selling price per computer and Q is sales quantity in units Marginal revenue (MR) equation: MR = 20,000 – 0.2Q The cost of manufacture is expected to be: Particulars of cost Taka per unit Direct materials (bought-in components) 4,000 Direct labor (assemble) 1,500 Variable overheads 500 Fixed overhead (apportioned) 2,000 Required: (i) For B Ltd. determine the price that should be set for the new toy in order to maximize profit. (ii) For E Ltd. determine the price that should be set for the new computer under two circumstances. (1)To maximize profit for E Ltd. (2) To maximize revenue for E Ltd. (iii) Briefly explain what is meant by market skimming, penetration pricing and market segmentation in the context of product pricing. (iv) Briefly discuss the typical issues that a company should consider when setting selling prices for a new product about to be launched. CMA Adapted – August 2012 227


E-27. A practicing Cost Accountant now spends Tk.9 per km on taxi fares for his clients work. He is considering two other alternatives, the purchase of a new small car or an old bigger car. New small car (Tk.) Old big car (Tk.) Purchase price 3,50,000 2,00,000 Sales price after five years 1,90,000 1,20,000 Repairs & Servicing per annum 10,000 12,000 Taxes & Insurance per annum 17,000 7,000 Diesel consumption per liter to run 10 kms 07 kms Diesel Price, per liter Tk.35 Tk.35 He is estimates that he can run 1,00,000 kms annually. Required: (1) Which of the three alternatives will be cheapest? (2) If his practice expands and he has to do 1,90,000 kms per annum, what should be his decision? (3) At how many kms per annum will the cost of two cars break-even and why? Ignore interest and income tax. CMA Adapted – December 2011 E-28. ABC Company Limited having an installed capacity of 1,00,000 units of product is currently operating at 70% utilization. At current levels of input prices, the FOB unit cost (after taking credit for applicable export incentives) work out as follows: Capacity utilization (per unit) FOB unit cost (in Tk.) 70.00 97.00 80.00 92.00 90.00 87.00 100.00 82.00 The company has received three foreign offers from different sources as under: Source A 5,000 units at Tk.55.00 per unit FOB Source B 10,000 units at Tk.52.00 per unit FOB Source C 10,000 units at Tk.51.00 per unit FOB Required: Advise the company as to whether any or all the export order should be accepted or not. CMA Adapted – August 2011 E-29. Mr. Hamid, Finance Officer, provides you with the following monthly data regarding product lines:Product-A Product-B Unit manufactured and sold 30,000 10,000 Selling price per unit Unit standard production and selling costs: Direct material Direct labour Factory overhead Selling commission Sales discount and allowances Advertising and sales production-(Fixed)

Taka 10

Taka 8

2 1 4 0.4 4,500 6,000

3 1 2 0.7 1,000 1,500 228


Variable overhead costs comprise 60% of the standard factory overhead. Marketing expenses of Tk.20,000 and Administrative expenses of Tk.10,000 were incurred by the central office. These are to be allocated to the product lines based on units sold. Production cost variance not traceable to either product line are as follows: Taka Material price variance 5,000 favorable Material quantity variance 10,000 favorable Labor rate variance 16,000 unfavorable Labor efficiency variance 8,000 unfavorable Overhead controllable variance 800 favorable Overhead volume variance 1,800 unfavorable These variance are distributed between the two product lines on the basis of relative total standard direct labour and factory overhead per period. Required: (1) Prepare a contribution analysis for each product line in total and on a per unit basis and for the overall company, including the allocation of non-traceable expenses so that income before taxes can be determined for each product line. (2) Management desires a 22% return on assets employed. Assets employed by product A total Tk.2,60,000 and Tk.87,500 for product B. In view of this, would you recommend discontinuation of either product line? Support your answer. CMA Adapted – April 2011 E-30. ABC company has asked your manager in determining the most profitable sales and production mix of its products. The company manufactures a line of toys. The sales department has provided you the following budgeted data: Toy Estimated demand Selling price per (in unit) toy (in Tk.) A 60,000 14.50 B 1,00,000 7.90 C 70,000 16.60 D 45,000 25.20 E 2,20,000 6.00 The cost accountant has developed the following additional data from the accounting files: (1) Standard direct production cost per unit are as follows: Product Material Labor (Toy) (in Tk.) (in Tk.) A 4.10 5.00 B 2.10 2.50 C 5.50 6.00 D 10.00 8.00 E 1.90 1.50 (2) The standard wage rate of Tk.10.00 per hour is expected to continue unchanged throughout the year. The plant has an effective production capacity of 1,51,000 labor hours per year on a single shift. The current equipment can be used to produce any and all of the products (toys). 229


(3) Variable manufacturing overhead is budgeted at Tk.3.00 per direct labor hour. Total fixed manufacturing overhead for the year is planned at Tk.10,00,000. Required: (i) Prepare a schedule that will be most useful to management in planning the product mix. Determine the amount of net income at such a product mmix. (ii) Is the present effective capacity on a single shift adequate to meet the estimated sales demand? If not, what will be the optimal product mix to keep production within the limits of a single shift? CMA Adapted – April 2011 E-31. A company manufactures 2,40,000 units per annum of product X at normal capacity with unit cost as under: Tk. Direct materials 7 Direct labour 2 Variable overheads 3 Fixed manufacturing overheads 4 Fixed selling and administrative overheads 4 Variable selling and administrative overheads 1 Selling price per unit 21 During the next quarter only 10,000 units can be produced and sold. If the plant is shut down, fixed manufacturing expenses can be reduced to Tk.70,000 at an additional cost of Tk.20,000. When the plant is operating, the fixed overheads are incurred at uniform rate on time basis. Required: As Management Accountant of the company, write a letter to the Managing Director giving your opinion on the alternatives, supported by data. CMA Adapted – August 2010 E-32. The Mathematical Engineering Co. Ltd. manufactures a range of products. While compiling the budget for the next financial year, the management realizes that a decision has to be made concerning the method of manufacture of a product, a precision-made blade. The blade is designed to sell for Tk.1 each. A choice must be made between three alternative production processes and the management seeks to find the most profitable method. The following information relates to the three processes A, B and C: Processes A B C Variable cost per product Tk.0.80 Tk.0.85 Tk.0.90 Fixed cost of process Tk.95,000 Tk.60,000 Tk.37,500 Maximum production in any process is one million blades. Required: (i) Determine the range of sales volumes for which each process is the most profitable. (ii) Enumerate other matters which would be taken into account before deciding which process to use. CMA Adapted – August 2010 230


E-33. A company manufactures and markets three products A, B, C. All the three products are made from the same set of machines. Production is limited by machine capacity. From data given below indicate priorities for products A, B and C with a view to maximize profits: Product - A Product - B Product - C Tk. Tk. Tk. Raw materials cost (per unit) 2.25 3.25 4.25 Direct labour (per unit) 0.50 0.50 0.50 Other variables cost (per unit) 0.30 0.45 0.71 Selling price (per unit) 5.00 6.00 7.00 Standard machine time required (per unit) 39 minutes 20 minutes 28 minutes In the following year, the company faces extreme shortage of raw materials. It is noted that 3 kg, 4 kg, and 5 kg of raw materials are required to produce one unit of A, B and C respectively. Required: How would product priorities change? CMA Adapted – August 2010 E-34. Iqbal manufacturers custom - made pleasure boats ranging in price from Tk.10,000 to Tk.250,000. For the past thirty years, Iqbal has determined each boatâ€&#x;s sales price by estimating the costs of materials, labor and a prorated portion of overhead and by adding 20% to these estimated costs. For example, a recent price quotation was determined as follows: Direct materials Direct labor Overhead Plus 20% Sales price

Tk.5,000 8,000 2,000 Tk.15,000 3,000 Tk.18,000

The overhead figure was determined by estimating the total overhead cost for the year and allocating it at 25% of direct labor. If a customer rejects the price and business is slack, Iqbal is often willing to reduce the markup to as little as 5% over estimated costs. Thus, average markup for the year is estimated at 15%. Iqbal has just completed a pricing course and believes that the company could use some of the modern techniques taught in the course. The course emphasized the contribution margin approach to pricing and Iqbal feels that such an approach would be helpful in determining the sales prices of custom-made pleasure boats. Total overhead (including marketing and administrative expenses for the year) has been estimated at Tk.150,000, of which Tk.90,000 is fixed and the remainder is variable in direct proportion to direct labor. Required: (i) (a) Compute the difference in profit for the year if a customerâ€&#x;s offer of Tk.15,000 instead of the Tk.18,000 price quotation shown above is accepted. 231


(b) Determine the minimum sales price Iqbal could have quoted without reducing or increasing profit. (ii) State the advantages that the contribution margin approach to pricing has over the approach used by Iqbal. (iii) Identify the pitfalls, if any, to contribution margin pricing. CMA Adapted – December 2009 E-35. A decision has to be taken relating to the possible introduction of a new product. There are three basic design version of this product aimed at different sections of the consumer market. The relevant figures are as follows Model-1 Model-2 Model-3 (Tk.) (Tk.) (Tk.) Variable cost per unit: Material 15 12 8.0 Labor 111 10 6.5 Variable overhead 4 3 3.0 Variable production cost 30 25 17.50 Selling price per unit 42.50 35 25 Expected sales volume per month in units 800 2,000 4,000 Capital expenditure necessary before 80,000 300,000 400,000 production can commence (financed by bank overdraft 6% p.a.) Fixed overhead per month attributable to new 2,800 8,500 11,000 models including depreciation on capital expenditure excluding interest Instructions: You are required to prepare a schedule of relative profitability showing for each model the figures making up expected total cost per unit, the expected profit per unit and the percentage of net profit to selling price at the expected sales volume. CMA Adapted – August 2009 E-36. A company currently operating at 80% capacity, has the following income statement: Sales Tk.640,000 Costs: Direct materials Tk.200,000 Direct labor 80,000 Variable overhead 40,000 Fixed overheads 260,000 580,000 Profit Tk.60,000 It has just received an offer of an overseas order that would require the use of half the factoryâ€&#x;s capacity. The order, which must be taken in full or rejected completely, must be supplied at prices 10% below current home prices. The following alternatives are available to the management: (i) Reject order and carry on with home sales only as currently; 232


(ii) Accept order, split capacity between overseas and home sales, and turn away excess home demand; or (iii) Increase factory capacity so as to accept the export order and maintain the present home sales level by: (a) buying machine that will increase factory capacity by 10% and fixed cost by Tk.20,000; and (b) work overtime at time and a half to meet balance of required capacity. Requirements: (i) Prepare comparative profitability statement for each of the alternatives. (ii) Which one should be chosen by the management and why? (iii) What other qualitative factors should be considered by the management at the time of making decision? CMA Adapted – August 2009 E-37. The Pramy Food Distribution Ltd. has decided to analyse the profitability of 5 customers during 6 months for its product „X‟ is Tk.0.50 and the listed selling price per unit is Tk.0.60 to wholesale customers. Data pertaining to 5 customers are: Customers Product sold (units) Listed selling price per unit Actual selling price per unit Number of purchase order Number of sales visit Number of delivery Kilometer travel per delivery Number of „Hot-hot runs‟

A B C D E 50,000 210,000 1,460,000 764,000 94,000 0.60 0.60 0.60 0.60 0.60 0.60 0.59 0.55 0.58 0.59 15 25 30 25 30 2 4 6 2 3 10 30 30 40 20 14 4 3 8 40 0 0 0 0 1

Its 5 activities area and their drivers are: Activity area Cost driver and rate Order taking Tk.100 per purchase order Sales visit Tk.80 per sales visit Delivery vehicles Tk.2 per delivery kilometer traveled Product handling Tk.0.02 per unit sold „Hot-hot runs‟ Tk.300 per hot-hot run „Hot-hot runs‟ is the emergency delivery outside the schedule. Required: (i) Compute the operating profitability statement for each customer. Comment on the result. (ii) What insights are gained by reporting the list selling price and the actual selling price for each customer? (iii) What factor should the Pramy Food Distribution Ltd. consider in deciding whether to crop one or more customer – A, B, C, D, E. CMA Adapted – April 2009

233


E-38. ABC company is currently manufacturing part K96, producing 50,000 units annually. The part is used in the production of several products made by the ABC. The cost per unit of K96 is as below: Taka Direct materials 7.00 Direct labour 3.00 Variable overhead 1.50 Fixed overhead 2.50 Total 14.00 Of the total fixed overhead assigned to K96 Tk.90,000 is direct fixed cost, which will not be needed if the line is dropped. The remaining fixed overhead is common cost. An outside supplier has offered to sell the part to ABC company for Tk.13. There is no alternative use of the facilities currently used to produce the part. Required: (i) Should ABC company make or buy, K96? (ii) What is the maximum amount ABC company would be willing to pay to outside supplier? (iii) If ABC company bought the part, by how much would income increase or decrease? CMA Adapted – April 2009

234


CHAPTER - 7 MANAGING SHORT TERM FINANCE

7.1. DEFINITION OF WORKING CAPITAL RATIO The working capital ratio is a ratio that measures a firm's ability to pay off its current liabilities with current assets. When current assets exceed current liabilities, the firm has enough capital to run its day-to-day operations. In other words, it has enough capital to work. The working capital ratio transforms the working capital calculation into a comparison between current assets and current liabilities. The working capital ratio is important to creditors because it shows the liquidity of the company. 7.2. DEFINITION OF WORKING CAPITAL CYCLE The working capital cycle is the amount of time it takes to turn the net current assets and current liabilities into cash. The longer the cycle is, the longer a business is tying up capital in its working capital without earning a return on it. 7.3. TYPES OF WORKING CAPITAL RATIOS Working capital ratios can be classified into various groupings, according to the type of information they convey. The main groupings are as follows: Current ratio: The current ratio is a liquidity ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities. Quick ratio: The quick ratio is a measure of how well a company can meet its short-term financial liabilities. It is also known as the acid-test ratio. It compares the total amount of cash + marketable securities + accounts receivable to the amount of current liabilities. Asset turnover ratio: Asset turnover ratio is the ratio of the value of a company's sales or revenues generated relative to the value of its assets. The asset turnover ratio can often be used as an indicator of the efficiency with which a company is deploying its assets in generating revenue. Debtor days: The debtor days represents the time lag between a credit sale and receiving payment from the customer. As debtor days relate to credit sales so the credit sales figure should be used to calculate the ratio. However the amount of credit sale is usually not separately available in the income statement so in that case total sales could be used. Debtor days can also be referred to as debtor collection period.

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Stock days: Stock days (also known as inventory days of supply, or the inventory period) is an efficiency ratio that measures the average number of days the company holds its stock before selling it. The ratio measures the number of days funds are tied up in stock. In determining stock days ratio, stock levels (measured at cost) are divided by sales per day (also measured at cost rather than selling price.) Creditor days: The creditor days represents the time lag between a credit purchase and making payment to the supplier. As creditor days relate to credit purchases so credit purchases figure should be used in calculating this ratio. However as the amount of credit purchase is usually not separately available in the income statement so in that case total purchases could be used. Creditor days can also be referred to as creditor payment period. Profitability (or performance) ratios: Profitability ratios indicate management's ability to convert sales taka into profits and cash flow. The common profitability ratios are gross margin, operating margin, net profit margin and return on capital employed. Liquidity (or solvency) ratios: The term „liquidity‟ refers to the ability of a concern to meet its long term obligations. The most common liquidity ratio is the current ratio, which is the ratio of current assets to current liabilities. This ratio indicates a company's ability to pay its short-term bills. Efficiency (or use of assets) ratios: Two common efficiency ratios are inventory turnover and receivables turnover. Inventory turnover is the ratio of cost of goods sold to inventory. The receivables turnover ratio is the ratio of credit sales to accounts receivable, which tracks outstanding credit sales. Capital structure (or gearing) ratios: The term capital structure refers to the relationship between various long term forms of financing such as debentures (long term), preference share capital and equity share capital including reserves and surpluses. Leverage or capital structure ratios are calculated to test the long term financial position of a firm. Generally capital gearing ratio is mainly calculated to analyse the leverage or capital structure of the firm. Security (or investors) ratio: Security or investors ratio is the measurement tools for company debt obligations against its assets. Security ratio allows the banker‟s to reasonably predict the future earnings of the company and to asses the risk of insolvency. This shows the overall liquidity position of company‟s current financial situation. Return on capital employed: Return on capital employed is a financial ratio that measures a company's profitability and the efficiency with which its capital is employed. A higher return on capital employed indicates more efficient use of capital.

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7.4. DEFINITION OF SHORT-TERM FINANCE Short-term finance refers to business or personal loans that have a shorter-than-average timespan for repaying the loan, typically one year or less. It is designed to help borrowers finance for an immediate need without the burden of long-term financing, though shortterm loans typically feature higher interest rates than regular loans. In many cases, shortterm loans are used to help a business build up inventory or raise capital when temporary deficiencies in funding occur. 7.5. FEATURES OF SHORT-TERM FINANCE i) Duration: Short-term finance embraces the borrowing or lending funds for short period of time say one year or less. ii) Cost of funds: Short-term finance can provide both the highest and lowest cost of funds in the firmâ€&#x;s capital structure. iii) Use of short-term finance: There is a common tendency for greater use short-term finance among small and lesser use among large concerns. iv) Sources of short-term finance: Short-term finance deals with the commercial bank, trade credit and other sources of funds that have to be repaid within a year or less. v) Renewal or recycling: This occurs when short-term liabilities are continually refinanced from financing must by definition be repaid in less that one year, some sources provide funds that are continuously rolled over. vi) Less restrictive: Short-term loan agreements ate generally less restrictive. Long-term loan agreements always contain previsions or covenants, which constrain firmâ€&#x;s future action these ate almost absent in short-term loan. viii) Easy collection and control: It is easy to collect and control short-term loan. No formalities are needed to raise funds from short-term source. ix) Security: short-term financing does not require any security to raise the funds. 7.6. CONCEPT OF EXPORT FINANCE Export finance helps organisation release working capital from cross border trade transactions that could otherwise be otherwise be tied up in invoices or purchase orders for up to 180 days. Export finance is specialist finance that can help grow a company and increase trade with large corporates. Export finance includes the following: Documentary credits: The documentary credit is one of the most secure payment methods in international trade, offering the exporter a conditional payment guarantee from the importer's bank. Documentary credits usually require the presentation of certain documents, which must be complied with before payment can take place.

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Bills of exchange: Bill of exchange can be defined as an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person, or to bearer. Export factoring: Export factoring is a complete financial package that combines export working capital, financing, credit protection, foreign accounts receivable bookkeeping and collection services. A factor is a bank or a specialized financial firm that performs financing through the purchase of invoices or accounts receivable. Forfeiting: Forfeiting is a means of financing used by exporters that enables them to receive cash immediately by selling their medium-term receivables at a discount and eliminate risk by making the sale without recourse, meaning the exporter has no liability regarding possible default by the importer on paying the receivables. The forfeiter is the individual or entity that purchases the receivables, so the importer is then obligated to pay the receivables amount to the forfeiter. A forfeiter is typically a bank or a financial firm that specializes in export financing.

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USEFUL FORMULAS Current assets Current liabilitie s Current assets excluding stock in trade 2. Quick (or, acid test) Ratio = Current liabilitie s

1. Current Ratio =

3. Inventory turnover ratio =

Cost of goods sold Average inventories

Operating profit Average capital employed Operatingprofit 5. Return on sales = Sales revenue Pr ofit for the year 6. Return on equity = Average equity Sales revenue 7. Net asset turnover = Capital employed (or net assets) Gross profit 8. Gross profit margin = Sales Re venue Gross profit 9. Gross profit mark-up = Cost of sales Net profit 10. Net profit margin = Net sales Sales revenue 11. Working capital turnover ratio = Net working capital Net income 12. Return on investment ratio = Total assets

4. Return on capital employed =

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PROBLEMS AND SOLUTIONS P-1. From the following extracts of the draft balance sheet, calculate the current ratio and quick (or, acid test) ratio and also give comments. Asset: Non-current assets Current assets: Stock in trade Accounts receivable Cash at bank

Taka

10 6 4 Total

Liabilities: Non-current liabilities Current liabilities: Accounts payables Pre-paid and advances Loan repayable in five years

Taka 15

20 35 20

8 4 3 Total

15 35

Solution: Current Ratio =

Current assets Current liabilitie s

Tk.20 Tk.15 = 1.33:1 Comment: This means for every Tk.1 owed by the company it has Tk.1.33 in assets to pay the debt.

=

Quick (or, acid test) Ratio =

Current assets excluding stock in trade Current liabilitie s

Tk.20  Tk.10 Tk.15 = 0.67:1 Comment: This means for every Tk.1 debt, the company has most liquid assets Tk.0.67 to pay the debt.

=

P-2. Calculate inventory turnover ratio and days inventories outstanding for ABC, Incorporation based on the information given below: Opening inventories Tk.25,000 Closing inventories Tk.30,000 Cost of goods manufactured Tk.245,000 240


Solution: Cost of goods sold = Tk.25,000 + Tk.245,000 – Tk.30,000 = Tk.240,000 Tk.25,000  Tk.30,000 2 = Tk.27,500

Average inventories =

Cost of goods sold Average inventories

Inventory turnover ratio =

Tk.240,000 Tk.27,500 = 8.73 365 Days inventories outstanding = 8.73 = 41.81 =

P-3. Nokia sells mobile telephones. The company has employed you as a consultant to install a balanced scorecard system of performance measurement and to benchmark the results. The financial and operating data for the year ended 31 December 2017 is available: Taka „000 Sales revenue 500 Opening capital employed 100 Opening capital employed 300 Opening equity 100 Closing equity 200 Operating profit 50 Calculate the following performance ratios: (a) Return on capital employed (b) Return on sales (c) Return on equity (d) Net asset turnover Solution: (a) Return on capital employed =

Operating profit Average capital employed

Here, Tk.100,000  Tk.300,000 2 = Tk.200,000

Average capital employed =

Tk.50,000 Tk.200,000 = 25%

Return on capital employed =

241


Comment: This means that for every Tk.1 capital invested in the business, operating profit is generated by Tk.25.

Operating profit Sales revenue Tk.50,000 = Tk.500,000 = 10% Comment: This means that if the company sells Tk.100, it makes operating profit Tk.10. (b) Return on sales =

(c) Return on equity =

Pr ofit for the year Average equity

Here, Tk.100,000  Tk.200,000 2 = Tk.150,000

Average equity =

Tk.50,000 Tk.150,000 = 33% Comment: This means that for every Tk.1 capital invested by the shareholders, final profit is generated by Tk.33. Return on equity =

Sales revenue Capital employed (or net assets) Tk.500,000 = Tk.200,000 = 2.5 times Comment: This means for every Tk.1 invested in the business Tk.2.5 of sales revenue has been generated. (d) Net asset turnover =

P-4. Income statement for the year ended December 31, 2017 and Comparative Statement of Financial Position as on December 31, 2017 of Hamid Corporation are given below: Hamid Corporation Comparative Statement of Financial Position As at December 31, 2017 Liabilities & Ownerâ€&#x;s Equity Taka Assets Taka Current Liabilities: Current Asset: Bank Overdraft 30,000 Cash at Bank 30,000 Sundry Creditors: Interest expense 20,000 Accounts Receivables 70,000 Credit purchase 80,000 Stock-in-trade 140,000 10,000 Total Current Liabilities: 130,000 Bill Receivables Long Term Debt - Total Current Asset: 250,000 Total Liabilities: 130,000 Long term Asset: 242


Common Stock (Tk.10 each) Profit & Loss Account General Reserve Total Liabilities & Ownerâ€&#x;s Equity

200,000 60,000 90,000 480,000

Machinery & Equipment Building Net Long term Asset: Total Assets

Hamid Corporation Income Statement For the year ended December 31, 2017 Particulars Taka Particulars Sales Cost of Sales: Opening Stock 90,500 Add: Purchases 559,500 650,000 Less: Closing Stock 140,000 510,000 Gross Profit c/d 340,000 850,000 Sales expenses 30,000 Gross Profit b/d Office expenses 150,000 Profit on sales of investments Financial expenses 15,000 Interest on investments Loss on sales of fixed assets 4,000 Net Profit 150,000 349,000

80,000 150,000 230,000 480,000

Taka 850,000

850,000 340,000 6,000 3,000

349,000

From the above financial statements calculate the following ratios and give your comments: (a) Current ratio (b) Quick ratio (c) Gross profit ratio (d) Gross profit margin (e) Net profit margin (f) Gross profit mark-up (g) Working capital turnover ratio (h) Return on investment ratio Solution:

Current assets (a) Current Ratio = Current liabilitie s Tk.250,000 = Tk.130,000 = 2:1 Comment: Current ratio of 2:1 means that current assets twice as large as current liabilities.

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Current assets excluding stock in trade Current liabilitie s (b) Quick Ratio = Tk.250,000  Tk.140,000 Tk.130,000 =

Tk.110,000 = Tk.130,000 = 1:1 Comment: Quick ratio of 1:1 means that the most liquid assets of the company are equal to its total debts.

Gross profit (c) Gross profit ratio = Net sales Tk.340,000 = Tk.850,000 = 40% Comment: Gross profit ratio is 40% means that the company may reduce the selling price of its products by 40% without incurring any loss.

Gross profit Sales revenue Tk.340,000 = Tk.850,000 = 40% Comment: Gross profit ratio is 40% means that the company may reduce the selling price of its products by 40% without incurring any loss. (d) Gross profit margin =

Net profit Net sales Tk.150,000 = Tk.850,000 = 18%

(e) Net profit margin =

Comment: Net profit ratio is 18% means that the company may reduce the selling price of its products by 18% without incurring any loss.

Gross profit Cost of sales Tk.340,000 = Tk.510,000 = 67%

(f) Gross profit mark-up =

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Comment: It shows that the selling price of the goods was equal to the cost of those goods plus 67 per cent of the cost. (g) Working capital turnover ratio =

Sales revenue Net working capital

Here, Net working capital = Current assets – Current liabilities = Tk.250,000 – Tk.130,000 = Tk.120,000

Tk.850,000 Tk.120,000 = 7 times

Working capital turnover ratio =

Comment: The working capital turnover ratio is 7. It means the company has turned over its working capital 7 times in 2016.

Net income (h) Return on investment ratio = Total assets Tk.150,000 = Tk.480,000 = 31% Comment: Return on investment ratio is 31% means that if Tk.100 is invested profit will be Tk.31. P-5. Hosaf Ltd. is a public company that would like to acquire (100%) a suitable private company. It has obtained the following draft financial statements for two companies, Padma Ltd. and Jamuna Ltd. They operate in the some industry and their managements have indicated that they would be receptive to a takeover. Income statements for the year ended 30 September 2017 Tk. ‟000 Revenue Cost of sales Gross profit Operating expenses Finance costs-loan Overdraft Lease Profit before tax Income tax expense Profit for the year Note: dividends paid during the year 245

Padma Ltd. Tk.‟000 12,000 (10,500) 1,500 (240) (210) nil nil 1,050 (150) 900 250

Jamuna Ltd. Tk. ‟000 20,500 (18,000) 2,500 (500) (300) (10) (290) 1,400 (400) 1,000 700


Statements of financial position as at 30 September 2017 Profit for the year 900 Assets Non-current assets Freehold factory [note (i)] 4.400 Owned plant [note (ii)] 5,000 Leased plant [note (ii)] Nil 9,400 Current assets Inventory 2,000 Trade receivables 2,400 Bank 600 5,000 Total assets 14,400 Equity and liabilities Equity shares of Tk. 1 each Property revaluation reserve Retained earnings Non-current liabilities Finance lease obligations [note (iii)] 7% loan notes 10% loan notes Deferred tax Government grants Current liabilities Bank overdraft Trade payables Government grants Finance lease obligations [note (iii) Taxation Total equity and liabilities

1,000

nil 2,200 5,300 7,500 3,600 3,700 nil

2,000 900 2,600 Nil 3,000 Nil 600 1,200 Nil 3,100 400 Nil 600

2,000 nil 800

3,500 5,500

4,800

4,100 14,400

7,300 14,800

3,200 Nil 3,000 100 Nil 1,200 3,800 Nil 500 200

800 2,800

6,300

5,700 14,800

Notes: (i) Both companies operate from similar premises. (ii) Additional details of the two companies‟ plant are: Padma Ltd. Jamuna Ltd. Tk. ‟000 Tk. ‟000 Owned plant – cost 8,000 10,000 Leased plant – original fair value Nil 7,500 There were no disposals of plant during the year by either company. (iii) The interest rate implicit within Jamuna Ltd.‟s finance leases is 7.5% per annum. For the purpose of calculating ROCE and gearing, all finance lease obligations are treated as long-term interest bearing borrowings. (iv) The following ratios have been calculated for Padma Ltd. and can be taken to be correct: Return on year end capital employed (ROCE) 14.8% (capital employed taken as shareholders‟ funds plus long-term interest bearing borrowings – see note (iii) above) Pre-tax return on equity (ROE) 19.1% Net asset (total assets less current liabilities) turnover 1.2 times 246


Gross profit margin Operation profit margin Current ratio Closing inventory holding period Trade receivables‟ collection period Trade payables‟ payment period (using cost of sales) Gearing [see note (iii) above] Interest cover Dividend cover

12.5% 10.5% 1.2:1 70 days 73 days 108 days 35.3% 6 times 3.6 times

Required: (a) Calculate for Jamuna Ltd. the ratios equivalent to all those given for Padma Ltd. above. (b) Assess the relative performance and financial position of Padma Ltd. and Jamuna Ltd. for the year ended 30 September 2017 to inform the directors of Hosaf Ltd. in their acquisition decision. Solution: (a) Equivalent ratios from the financial statement of Jamuna Limited: All figures are in Tk.‟000

7,300 5,700 = 13:1

Current ratio =

(1,400  590) X 100 (2,800  3,200  500  3,000) = 20.9%

Return on year end capital employed (ROCE) =

1,400 X 100 2,800 = 50%

Pretax return on equity (ROE) =

20,500 X 100 (14,800  5,700) = 2.3 times

Net asset turnover =

2,500 X 100 20,500 = 12.2%

Gross profit margin =

2,000 X 100 20,500 = 9.8%

Operating profit margin =

3,600 X 365 18,000 = 73 days

Closing inventory holding period =

247


3,700 X 365 20,500 = 66 days

Trade receivables‟ collection period =

3,800 X 365 18,000 = 77 days

Trade payables‟ payment period =

(3,200  500  3,000) X 100 9,500 = 71%

Gearing =

2,000 600 = 3.3 times

Interest cover =

1,000 700 = 1.4 times

Dividend cover =

As per the question, Jamuna Ltd‟s obligations under finance leases (3,200 + 500) have been treated as debt when calculating the ROCE and gearing ratios. (b) Assessment of the relative performance and financial position of Padma Ltd. and Jamuna Ltd. of the year ended 30 September 2017. Introduction This report is based on the draft financial statements supplied and the ratios shown in (a) above. Although covering many aspects of performance and financial position, the report has been approached from the point of view of a prospective acquisition of the entire equity of one of the two companies. Profitability The ROCE of 20.9% of Jamuna Ltd. is far superior to the 14.8% return achieved by Padma. ROCE is traditionally seen as a measure of management‟s overall efficiency in the use of the finance/assets at its disposal. More detailed analysis reveals that Jamnua Ltd‟s superior performance is due to efficiency in the use of its net assets; it achieved a net asset turnover of 2.3 times compared to only time for Grappa. Put another way, Jamuna Ltd. makes sales of Tk. 2.30 per Tk. 1 invested in net assets compared to sales of only Tk.1.20 per Tk.1 invested for Padma. The other element contributing to the ROCE is profit margins. In this area Jamuna Ltd‟s overall performance is slight inferior to that of Padma, gross profit margins are almost identical, but Padma‟s operating profit margin is 10.5% compared to Jamuna Ltd‟s 9.8%. In This situation, where one company‟s ROC superior to another‟s it is useful to look behind the figures and consider possible reasons for the superiority other than the obvious one of greater efficiency on Jamuna Ltd‟s part. A major component of the ROCE is normally the carrying amount of the non-current assets. Consideration of these in this case reveals some interesting issues. Jamuna Ltd. 248


does not own its premises whereas Padma Ltd. does. Such a situation would not necessarily give a ROCE advantage to either company as the increase in capital employed of company owning its factory would be compensated by a higher return due to not having a rental expense (and vice versa). If Jamuna Ltd. rental cost, as a percentage of the value of the related factory, was less than its overall ROCE, then it would be contributing to its higher ROCE. There is insufficient information to determine this. Another relevant point may be that Jamuna Ltd‟s owned plant is nearing the end of its useful life (carrying amount is only 22% of its cost) and the company seems to be replacing owned plant with leased plant. Again this does not necessarily give Jamuna Ltd. an advantage but the finance cost of the leased asset at only 7.5% is such lower than overall ROCE (of either company) and therefore this does help to improve Jamuna Ltd‟s ROCE. The other important issue within the composition of the ROCE is the valuation basis of the companies‟ non-current assets. From the question, it appears that Padma‟s factory is at current value (there is a property revaluation reserve) and note (ii) of the question indicates the use of historical cost for plant. The use of current value for the factory (as opposed to historical cost) will be adversely impacting on Padma‟s ROCE. Jamuna Ltd. does not suffer this deterioration as it does not own it factory. Gearing From the gearing ratio it can be seen that 71% of Jamuna Ltd.‟s assets are financed by borrowings (39% is attributable to Jamuna Ltd‟s policy of leasing its plant). This is very high in absolute terms and double Padma‟s level of gearing. The effect of gearing means that all of the profit after finance costs is attributable to the equity even though (in Jamuna Ltd‟s case) the equity represents only 29% of the financing of the net assets. Whilst this may seem advantageous to the equity shareholders of Jamuna Ltd., it does not come without risk. The interest cover of Jamuna Ltd. is only 3.3 time whereas that of Padma Ltd. is 6 times. Jamuna Ltd‟s low interest cover is a direct consequence of its high gearing and it makes profits vulnerable to relatively small changes in operating activity. For rating example, small reductions in sales, profit margins or small increases in operating expenses could result in losses and mean that interest charges would not be covered. Another observation is that Padma Ltd. has been able to take advantage of the receipt of governm grants; Jamuna Ltd. has not. This may be due to Padma Ltd. purchasing its plant (which may then eligible for grants) whereas Jamuna Ltd.asLes its plant. It may be that the lessor has received any grants available on the purchase of the plant and passed some of this benefit on to Jamuna Ltd. lower lease finance costs (at 7.5% per annum, this is considerable lower than Jamuna Ltd. has to pay on its 10% loan notes). Liquidity Both companies have relatively low liquid ratios of 1.2 and 1.3 for Padma Ltd. and Jamuna Ltd respectively, although a least Padma Ltd. has Tk.600,000 in the bank whereas Jamuna Ltd. has a Tk.1.2 million overdraft. In this respect Jamuna Ltd‟s policy of high dividend payouts (leading to a low dividend cover and low retained earnings) is very questionable. Looking in to more depth, both companies have similar inventory days; Jamuna Ltd. collects its receivables one week earlier than Padma Ltd. (perhaps its credit control procedures are more active due to its large overdraft), and notable difference is that Padma Ltd. Receives (or takes) a lot longer credit period from its supplier (108 days

249


compared to 77 days). This may be a reflection of Padma Ltd. Being able to negotiate better credit terms because it has a higher credit rating. Summary Although both companies may operate in a similar industry and have similar profits after tax, they would represent very different purchases. Jamuna Ltd‟s sales revenues are over 70% more than those of Padma Ltd, it is financed by high levels of debt, it rents rather than owns property and it choose to lease rather than buy its replacement plant. Also its remaining owned plant is nearing the end of its life. Its replacement will either require a cash injection if it is to be purchased (Jamuna Ltd‟s overdraft of Tk.1.2 million already requires serious attention) or create even higher levels of gearing if it continues its policy of leasing. In short although Jamuna Ltd‟s overall return seems more attractive than that of Padma, it would represent a much more risky investment. Ultimately the investment decision may be determined by Hosaf‟s attitude to risk, possible synergies with it existing business activities, and not least, by the asking price for each investment (which has n been disclosed to us).

250


CHAPTER - 8 ECONOMIC ORDER QUANTITY

8.1. MEANING OF ECONOMIC ORDER QUANTITY Economic order quantity (EOQ) refers to the unit of each order at which ordering cost and inventory carrying cost will be minimum over a period of time with a stable level of demand. 2 X Annual demand X Cost per order EOQ = Carrying cos t X Carrying cos t percentage A company uses EOQ model to minimise the total cost of holding and ordering inventory. 8.2. PRINCIPLES OF ECONOMIC ORDER QUANTITY MODEL i) The use of inventories by the company remains constant ii) Lead time is constant iii) Purchase price is constant iv) Unit carrying cost and ordering cost of inventory is constant 8.3. CRITICISMS OF ECONOMIC ORDER QUANTITY MODEL What quantity will be demanded by the customer in market and what quantity should be hold in the stores are totally based on the assumptions. The assumptions sometime may be right or may be wrong and this is the major criticism of the EOQ model. It requires continuous monitoring of inventory level. It is a time consuming process and need accuracy in calculation. 8.4. DEFINITION OF CENTRALISED AND DECENTRALISED PURCHASING In centralized purchasing buying and managing process is performed from one location to all locations within an organization. This can also be run by a central location buying into a distribution warehouse that feeds smaller warehouses. In large firms there are many branches, sect ions or departments. If each branch or department buys its own materials and equipment, it is known as decentralized purchasing. 8.5. CENTRALISED VERSUS DECENTRALISED PURCHASING i) In centralized purchasing all purchases are made by single purchase department. In decentralized purchasing purchases are made by each production department on their own. ii) If top manager make the organizationâ€&#x;s decisions with little or no input from subordinates then the organization is centralized. When the managers and supervisors at the middle and lower levels are given considerable autonomy in decision-making, the organization is considered to be decentralized. 251


iii) Centralized purchasing is normally used in larger organisations and decentralized purchasing is used in smaller organisations. iv) In centralized purchase, due to bulk purchase material can be purchased at discount rate and in decentralized purchase no discount is available on purchase. 8.6. RELATIONSHIP BETWEEN PURCHASING AND STOCK CONTROL Purchase and stock control management automates and monitors the procurement process of an organization thereby optimize the organization‟s total purchase and stock workflow. The stock control supports the entire purchase work flow from request through purchasing and receiving the goods as well as the entire stock workflow from spare part management to warehouse configuration. 8.7. DEFINITION OF INVENTORY MANAGEMENT SYSTEM Inventory management system is the supervision of non-capitalized assets (inventory) and stock items. It supervises the flow of goods from manufacturers to warehouses and from these facilities to point of sale. A key function of inventory management system is to keep a detailed record of each new or returned product as it enters or leaves a warehouse or point of sale. 8.8. OBJECTIVES OF INVENTORY MANAGEMENT SYSTEM i. To keep inventory at sufficiently high level to perform production and sales activities smoothly. ii. To minimize investment in inventory at minimum level to maximize profitability. iii. To keep investment in inventory at optimum level. iv. To ensure that the supply of raw material & finished goods will remain continuous. v. To minimize carrying cost of inventory. vi. To minimize inventory ordering costs. 8.9. DEFINITION OF INVENTORY CONTROL SYSTEM An inventory control system is a system that encompasses all aspects of managing a company's inventories; purchasing, shipping, receiving, tracking, warehousing and storage, turnover, and reordering. 8.10. CLASSIFICATION OF INVENTORY CONTROL SYSTEM Generally, three main inventory control systems are used. These are as follows: i) Reorder level system: With this system, whenever the current inventory level falls below a pre-set reorder level, a replacement order is made. A reorder level system is simple enough to implement if the variables (such as annual usage, lead time, etc) are known with certainty. ii) Periodic review system: In this system, inventory levels are reviewed after a fixed interval, for example, on the first of the month. Replacement orders are issued when necessary. This means that order sizes are variable. This is also known as „constant cycle‟. 252


iii) Mixed system: It is the mixtures of reorders level system and periodic review system. In practice, mixtures of both systems are sometimes used depending on the nature of problem. 8.11. SHORT NOTES Holding cost: Holding costs are the costs associated with storing inventory that remains unsold and these costs are one component of total inventory costs along with ordering costs and shortage costs. A firmâ€&#x;s holding costs include the cost of goods damaged or spoiled as well as the cost of storage space, labor and insurance. Ordering cost: Ordering costs are the expenses incurred to create and process an order to a supplier. These costs are included in the determination of the economic order quantity for an inventory item. Lead time: Lead time is the amount of time between placing an order and receipt of the final product. Safety stock Safety stock (also called buffer stock) is the amount of stock required to continue production in case if lead time is increased or consumption is increased. It is a basic level of inventory held as a reserve in case there is future demand and supply fluctuations. Order point: Order point means the time as well as inventory level when an order should be made with supplier to bring the inventory. Stockout: It is a situation in which the demand or requirement for an item cannot be fulfilled from the current inventory.

253


USEFUL FORMULAS 1. Economic order quantity (EOQ) =

2 DO C C%

Where, D = Annual demand O = Cost per order C = Unit carrying cost C% = Carrying cost percentage 2. Safety stock = (Maximum use - Normal use) X Lead time 15. Order point or Reorder point or Reorder level = (Normal use X Lead time) + Safety stock Or, Order point or Reorder point or Reorder level = Maximum use X maximum lead time 3. Normal maximum inventory = (Order point – Normal use during lead time) + EOQ Or, Normal maximum inventory = EOQ + Safety stock 4. Absolute maximum inventory = (Order point – Minimum use during lead time) + EOQ Or, Absolute maximum inventory = EOQ + Safety stock + (Normal use – Minimum use) X Lead time 5. Average inventory = (Order point – Normal use during lead time) +

EOQ 2

6. Maximum stock level = (Order point – Minimum use during minimum lead time) + EOQ 7. Minimum stock level = Maximum use during maximum lead time – Normal use during normal lead time 8. Total cost = Ordering cost + Carrying cost 9. Ordering cost =

Annual demand X Cost per order EOQ

10. Carrying cost = Average inventory X Unit carrying cost X Carrying cost percentage 11. Average inventory =

EOQ 2

12. Number of orders per year =

Annual demand EOQ

254


PROBLEM AND SOLUTIONS P-1. LMX Company has a Chittagong plant that manufactures MP3 players. One component is an XT chip. Expected demand is for 5,200 of these chips in March 2017. LMX estimates the ordering cost per purchase order to be Tk.2,500. The monthly carrying cost for one unit of XT in stock is Tk.50. Required: (a) Compute the EOQ for the XT chip. (b) Compute the number of deliveries of X in March 2017. Solution:

2 DO C 2 X 5,200 X Tk.2,500 = Tk.50 = 721 chips

(a) EOQ =

5,200 721 = 8 (rounded)

(b) Compute the number of deliveries =

P-2. The Hedge Corporation manufactures only one product: plank. The single raw material used in making planks is the dint. For each plank manufactured, 12 dints are required. Assume that the company manufactures 1,50,000 planks per year, that demand for planks is perfectly steady throughout the year, that it costs Tk.200 each time dints are ordered, and that carrying costs are Tk.8 per dint per year. Required: (a) Determine the economic order quantity of dint. (b) What are total inventory costs for Hedge (carrying cost plus ordering cost)? (c) How many times per year would inventory be ordered? Solution: 2 DO C 2 X (18,00,000 X 12) Tk.200 = Tk.8 = 9,487 dints

(a) EOQ =

(b) Total inventory costs = Ordering costs + Carrying costs CQ DO = + 2 Q 18,00,000 X 200 8 X 9,487 = + 9,487 2 = 37,946.66 + 37,948 = 75,894.66 255


D Q 18,00,000 = 9,487 = 190 times per year

(c) Number of orders per year =

P-3. A company‟s annual purchases of 10,000 sub-assembled parts at Tk.100 each is being experienced. Per order and receiving cost is Tk.200 and carrying cost is 25%. Required: (a) Compute EOQ. (b) The company can only invest Tk.10,000 at a time to purchase. What would be the possible loss for non-attaining EOQ? (c) If the company plans to borrow additional fund to cover the loss, what would be the maximum yearly rate of the borrowed fund? Solution:

2 DO CC % 2 X 10,000 X Tk.200 = Tk.100 X 25% = 400 units

(a) EOQ =

(b) Maximum units to purchase (10,000 ÷ 100) Number of order Ordering cost Size of order Average Carrying cost (25%) Total cost (Ordering cost + Carrying cost)

Constraint 100 units 100 Tk.20,000 10,000 5,000 Tk.1,250 Tk.21,250

Free 400 units 25 Tk.5,000 40,000 20,000 Tk.5,000 Tk.10,000

Loss = Tk.21,250 – Tk.10,000 = Tk.11,250

(21,250  10,000) (40,000  10,000) = 37.50

(c) Maximum rate of borrowed fund =

P-4. Mosaj & Associates has developed the following costs and other data pertaining to one of its raw materials: Normal use per day 400 units Maximum use per day 600 units Minimum use per day 100 units Working days per year 250 256


Lead time Cost of placing one order Cost per unit of material Carrying cost percentage

8 days Tk.20 Tk.2.5 10%

Compute the following: (a) Economic order quantity. (b) Safety stock. (c) Reorder point. (d) Normal maximum inventory. (e) Absolute maximum inventory. (f) Average normal inventory. Solution: (a) Economic order quantity (EOQ) = =

2 DO C C%

2 X (400 X 250) X 20 2.50 X 10%

40,00,000 0.25 = 4,000 units (b) Safety stock (maximum) = (Maximum use per day - Normal use per day) X Lead time = (600 – 400) X 8 = 1,600 units =

(c) Reorder point = (Normal use per day X Lead time) + Safety stock = (400 X 8) + 1,600 = 4,800 units (d) Normal maximum inventory: Safety stock Add: EOQ (e) Absolute maximum inventory: Normal maximum inventory Normal use per day Minimum use per day

(f) Average normal inventory: Safety stock Add: EOQ á 2

1,600 units 4,000 units 5,600 units 5,600 units 400 units 100 units 300 units X 8 days

2,400 units 8,000 units 1,600 units 2,000 units 3,600 units

P-5. ABC Company has the following costs data for its material X: Normal use per month 12,500 units Maximum use per month 13,000 units Minimum use per month 8,000 units 257


Lead time Ordering cost per order Carrying cost per unit Carrying cost percentage Compute: (a) EOQ. (b) Safety stock (maximum). (c) Order point. (d) Normal maximum inventory. (e) Absolute maximum inventory. (f) Average inventory.

2 months Tk.50 Tk.150 10%

Solution: (a) Economic order quantity (EOQ) = =

2 DO C C%

2 X (12,500 X 12) X 50 150 X 10%

1,50,00,000 15 = 1000 units =

(b) Safety stock (maximum) = (Maximum use per month - Normal use per month) X Lead time = (13,000 – 12,500) X 2 = 1,000 units (c) Order point = (Normal use per month X Lead time) + Safety stock = (12,500 X 2) + 1,000 = 26,000 units (d) Normal maximum inventory: Order point Less: Normal use during lead time (12,500 X 2) Add: EOQ (e) Absolute maximum inventory: Order point Less: Minimum use during lead time

(8,000 X 2)

Add: EOQ (f) Average inventory: Order point Less: Normal use during lead time Add: EOQ á 2

(12,500 X 2)

26,000 units 25,000 units 1,000 units 1,000 units 2,000 units 26,000 units 16,000 units 10,000 units 1,000 units 11,000 units 26,000 units 25,000 units 1,000 units 500 units 1,500 units 258


P-6. For a particular material, the following information has been gathered: Normal use per day 3,000 units Maximum use per day 4,000 units Minimum use per day 1,000 units Delivery period from suppliers: Maximum 7 days; Normal 5 days; Minimum 3 days Economic order quantity is 8000 units. Required: (a) Reorder level (b) Maximum Stock level (c) Minimum Stock level Solution: (a) Reorder level = Maximum use per day X maximum lead time = 4,000 X 7 = 28,000 units (b) Maximum stock level Reorder level Less: Minimum use during minimum lead time (1,000 X 3) Add: EOQ

28,000 units 3,000 units 25,000 units 8,000 units 33,000 units

(c) Minimum stock level = Maximum use during maximum lead time – Normal use during normal lead time = (4,000 X 7) – (3,000 X 5) = 28,000 – 15,000 = 13,000 units P-7. Best Electronics (BE) is thinking to run mega store specially sports cloths. It uses an EOQ decision model to make inventory decisions. They are now considering inventory decisions for its Manchester United (Man U) football jerseys. This is a high popular item. Data for 2017 are: Expected annual demand for Man U jerseys Ordering cost per purchase order Carrying cost per year per jersey The purchasing lead time

- 8,000 nos - Tk.2,00.00 - Tk.7.00 - 7 days (BE is open 365 days a year)

Actually United Garments (UG) manufacturing the Man U jerseys that BE sells to its customers. UG has recently installed computer software that enables its customer to conduct “One Stop Purchase” using state-of-the-art website technology. Then BE‟s ordering cost per purchase order will be reduced to Tk.30.00 using this online technology.

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Required: (a) Compute the EOQ. (b) Compute the number of order that will be placed in a year. (c) Compute the reorder point. (d) Calculate the EOQ for the Man U jerseys using the reduced ordering cost assume no change in carrying cost. (e) Suppose UG will allow BEâ€&#x;s customer to order directly from the UG website. UG ships directly to those customers. UG would pay Tk.10 to BE for every jersey purchased by one BE customer. Comment qualitative on how this offer would affect inventory management at BE. Solution: 2 DO C 2 X 8,000 X Tk.200 = 7 = 676 jerseys

(a) EOQ =

D Q 8,000 = 676 = 12 orders per year

(b) Number of orders per year =

D No. of working days 8,000 = 365 = 12.91 jerseys per day

(c) Demand for each working day =

Purchase lead time = 7 days

21.91 7 = 153 jerseys

Reorder point =

2 DO C 2 X 8,000 X Tk.30 = 7 = 262 jerseys

(d) EOQ =

The reduction of ordering cost from Tk.200 to Tk.30 on per purchase order has reduced the EOQ from 676 jerseys to 262 jerseys.

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(e) The UG proposal has both upsides and downsides. The upside is potentially higher sales. BE customers may purchase more on online than if they have to physically visit a store. BE would also have lower administrative costs and lower inventory holding costs with the proposal. The downside is that UG could capture BEâ€&#x;s customers. Repeat customers to the UG website need not be classified as BEâ€&#x;s customers. BE would have to establish enforceable rules to make sure it captures ongoing revenues from customers it directs to the UG website. P-8. XYZ Company uses a material 30,000 units per year for which cost of placing one order is Tk.40, unit carrying cost is Tk.96 and carrying cost percentage is 10%. The company follows JIT inventory system and the order size may be from 500 to 800 units in multiplies of 100. You are required to determine the purchase order quantity that will minimize cost by tabular method. Apply the EOQ formula to prove your answer. Solution: Determination of cost per annum that will minimize cost by tabular method: Order size in units (Q) 500 600 700 No. of order per year (D/Q) 60 50 42.86 Average inventory in units (Q/2) 250 300 350 Total ordering cost in Tk. 2,400 2,000 1,714 (D/Q X Tk.40) Total carrying cost in Tk. 2,400 2,880 3,360 (Q/2 X Tk.96 X 10%) Total cost in Tk. 4,800 4,880 5,074 (Ordering + Carrying cost)

800 37.50 400 1,500 3,840 5,340

As, the total cost Tk.4,800 is minimum when the purchase order quantity is 500 units. So, it will minimize cost. Applying the EOQ formula: Economic order quantity (EOQ) = =

2 DO C C%

2 X 30,000 X 40 96 X 10%

24,00,000 9.6 = 500 units =

P-9. A company uses material A60 in its continuous production process that has an annual demand of 80,000 units. The cost per unit is Tk.10 and materials can be received immediately. Per order cost is Tk.100 and unit holding cost is Tk.1 per annum. The company has two discount policies. A. 5% discount is available if the order size is at least 4,000 units. B. 8% discount is available if the order size is 5,000 units or above. Calculate the order quantity that will optimal. 261


Solution: 2 DO C 2 X 80,000 X 100 = 1 1,60,00,000 = 1 = 4,000 units

Economic order quantity (EOQ) =

Since the order quantity is 4,000 units, it is qualify for 5% discount. Calculation of total cost when order size is 4,000 units: Total cost = Ordering cost + Holding cost Q D =( X O) + ( X C) 2 Q 80,000 4,000 =( X 100) + ( X 1) 4,000 2 = 2,000 + 2,000 = 4,000 Calculation of total cost when order size is 5,000 units: 80,000 5,000 Total cost = ( X 100) + ( X 1) 5,000 2 = 1,600 + 2,500 = 4,100 Extra cost of ordering 5,000 units (Tk.4,100 – Tk.4,000) Less. Saving on extra discount (8% - 5%) X Tk.10 X 80,000 Net cost saving

Tk.(100) Tk.24,000 Tk.23,900

Since the order quantity 5,000 units saves the cost by Tk.23,900, so it is the optimal order quantity. P-10. Agora sells its three products in a package. The sale price of the package is Tk.150. The annual demand is 1,50,000 packages. The manufacturing cost per package is Tk.150. The lead time is 5 days. The ordering cost is Tk.50 and holding cost is 10% per annum. The economic order quantity is given by 1,000 units and safety stock level is zero. Required: If the inventory in hand is 2,084 units, when Agora should the next order be placed? (One year = 360 days) Solution: Number of days to give each order =

Days in a year No. of orders per year

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Annual demand EOQ 1,50,000 = 1,000 = 150

Here, Number of orders per year =

360 150 = 2.4 days

So, Number of days to give each order =

2.4 X 2,084 1,000 = 5 days

Inventory remains for the no. of days =

No. of days remains for next order = 5 – 5 = 0 day So, the next order should be placed immediately P-11. A Chinese Company prepares 9,000 computers annually. Ordering cost is Tk.10.00 per order and carrying cost per computer is Tk.4.00. It takes 8 days to arrive the computer from placement of an order. From the past experience the company estimates following stockout probability percentages. Safety stock (Units) 100 150 200 250

Stockout probability (%) 30 25 20 15

Cost of a stockout Tk.40 per occurrence number of orders per year 20. You are required to find out the optimal safety stock for the company. Solution: Total ordering cost of safety stock: Units of safety stock (1) 100 150 200 250

263

No. of orders per year (2) 20 20 20 20

Probability of stockout % (3) 30 25 20 15

Weighted probability of stockout (4=2X3) 6 5 4 3

Cost of stockout (5) 40 40 40 40

Total ordering cost (6=4X5) 240 200 160 120


Total carrying cost of safety stock: Units of safety stock (1) 100 150 200 250

Carrying cost per unit (2) 4 4 4 4

Total carrying cost (3=1X2) 400 600 800 1,000

The optimal safety stock: Units of safety stock (1) 100 150 200 250

Total ordering cost (2)

Total carrying cost (3)

Total cost (4=2+3)

240 200 160 120

400 600 800 1,000

640 800 960 1,120

As, the total cost Tk.640 is minimum for 100 units. So, the optimal safety stock is 100 units. P-12. GSK Plc. a rapidly growing pharmaceuticals company, over the last couple of months has been experiencing stockouts on one of its important chemical used for children skincare lotion. The management, after having a series of discussion with procurement department, production department as well as the existing suppliers in the industry finds out that, the lead time for delivery is one month from the date of order and actual and forecasted usage during the past three quarters are as follows: Quarter1 Usage Forecast Quarter2 Usage Forecast Quarter3 Usage Forecast Month 1 475 490 Month 1 500 485 Month 1 500 510 Month 2 480 490 Month 2 510 500 Month 2 490 510 Month 3 490 475 Month 3 520 510 Month 3 485 500 The management also estimated that, 97.5 percent protection against a stockout is adequate. As an Executive Production of that company, you are required to furnish the following information before the management. Requirement: (a) A schedule showing the safety stock required. (b) The safety stock required if the normal lead time is two months. Solution: (a) GSK Plc. Schedule of Safety Stock

264


Quarter 1 Month 1 Month 2 Month 3 Quarter 2 Month 1 Month 2 Month 3 Quarter 3 Month 1 Month 2 Month 3 Total = 9 1,700 -

Forecast 490 490 475

Usage 475 480 490

Deviation 15 10 -15

Deviation square 225 100 225

485 500 510

500 510 520

-15 -10 -10

225 100 100

510 510 500

500 490 485

10 20 15 20

100 400 225 1,700

(20) 2 400 = 1,700 = 1,700 – 44.4 = 1,655.6 9 9

Standard deviation =

1,655.6 9 1

= 206.95 = 14.39 20 = 2.22 Average of the difference of forecast requirements from actual usage 9

The required safety stock = (14.39 X 2) – 2.22 = 28.78 – 2.22 units = 27 units (rounded) (b) The required safety stock, if the lead time is 2 months = (14.39 X 2 X 2) – (2.22 X 2) = (28.78 X 1.41) – 4.44 = 40.58 – 4.44 = 36 (rounded)

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EXERCISES E-1. BETA LTD‟s cost sheet gives you the following information: Items of Revenue/Cost Taka/unit Raw Material cost 117 Direct Labour 49 Factory overhead (includes depreciation at 98 Taka 18 per unit of budgeted level of activity) Total cost per unit 264 Profit 36 Selling price per unit 300 The following information is also available: Average raw material in stock 4 weeks Average work in progress stock (Material 80% complete, 2 weeks Labour and OH – 60% complete) Credit period allowed to debtors 6 weeks Credit availed from suppliers 8 weeks Time lag in payment of wages 1 week Time lag in payment of overheads 2 weeks The company sells one fifth of its output against cash and the remaining is credit sale. Cash balance is maintained at Taka 250,000. Budgeted level of activity is 78,000 units. Production, wages and overheads may be taken as being carried out evenly throughout the year. Debtors may be valued at sales value. Assume 52 weeks a year. Prepare a statement showing the item wise break up of the total working capital requirement needed to finance the budgeted level of activity. CMA Adapted – June 2017 E-2. ZETA Ltd produces a product which has a weekly demand of 2500 units. The product requires 5 kg material for every finished unit of product. Purchase price is Taka 104 per unit. The ordering cost is Taka 200 per order and the carrying cost is 10% per annum. (i) Calculate the Economic Order Quantity. (ii) Should the company accept an offer of 3% discount by the supplier who wants to supply the annual requirement of the material in five installments? CMA Adapted – June 2017 E-3. RG Group sales fashionable mobile phone. It expects annual demand for a latest model Universe–Z2 to be 35,500 units. As a latest model, Universe–Z2 can be sold at a price of Tk.2,700/- per unit and RG Group places an order for 5,500 units of Universe-Z2 at regular intervals throughout the year. Because the demand for Universe-Z2 is to some degree uncertain. RG Group generally maintains a safety stock of Universe-Z2 which is sufficient to meet demand for 23 working days. The cost of placing an order is Tk.3,300/and the storage cost for Universe-Z2 is Tk.25 per unit per year. RG Group normally pays its suppliers after 90 days but XIN Company has offered a discount of 1.5% for cash settlement within 10 days. RG Group has a short-term bank loan which cost at 7% and uses a working year consisting of 360 days. 266


Required: (i) Determine the total cost of the current ordering policy per annum. (Ignore financing costs). (ii) Find the annual saving if the EOQ model is used to determine an optimal ordering policy. (Ignore financing costs). (iii) Determine whether the discount offered by the supplier is financially acceptable to RG Group. (iv) Differentiable between Factoring and Bills discounting. (v) Discuss the advantages to a company of taking steps to improve its working capital management, giving examples of steps that might be taken. CMA Adapted – December 2016 E-4. A company manufactures two products, X and Y. Product X requires 5 hours to produce while Y requires 10 hours. In July, 2015, it operates 25 effective working days with 8 hours a day. During this period, 1,000 units of Product X and 600 units of Product Y were produced. The company employs 50 workers in the production department to produce products X and Y. The budgeted hours are 102,000 for the year. Required: Calculate capacity ratio, activity ratio and efficiency ratio. Also establish their interrelationship. CMA Adapted – December 2015 E-5. Assume that “Fire Fighter” produces Type C fire extinguishers. It makes 30,000 of these fire extinguishers per year. Each extinguisher requires one handle (assume a 300 day work year for daily usage rate purposes). Assume an annual carrying cost of Tk.1.50 per handle, production setup cost of Tk.150, and a daily production rate of 300. Required: What is the optimal production order quantity? CMA Adapted – December 2015 E-6. Confidence Cement Limited needs to finance seasonal needs in inventory. Its considered the following alternative methods: (A) A factor is ready to buy the company‟s Accounts Receivables of Tk.1,25,000 per month which have an average collection period of 60 days. The factor will advance upto 80 percent of the face value of the A/R at 12 percent interest per annum and will also charge 2.5 percent commission. It is also estimated that the factor‟s service would save credit administrative cost of Tk.1,500 per month and bad debt loss of 2 percent. (B) A commercial paper with a face value of Tk.1,000 each sold for Tk.955 for 120 days. The floatation cost is Tk.5. (C) The company wants to borrow Tk.2 Lac from Sonali Bank for one year to meet the working capital requirement. The bank has given two alternatives: (i) 12 percent interest rate with 20 percent compensating balance requirement. (ii) 14 percent interest rate with 10 percent compensating balance requirement. As a finance manager of the company which of the above alternatives method of financing would you prefer? Justify your answer. CMA Adapted – December 2015 267


E-7. Apex Company has obtained the following costs and data pertaining to one of its materials: Working days per year 250 Normal use per day 500 units Maximum use per day 600 units Minimum use per day 100 units Lead time 5 days Variable cost of placing one order Tk.36 Variable carrying cost per unit per year Tk.4 You are required to compute: (i) EOQ. (ii) Safety stock (Maximum). (iii) Order point (iv) Normal maximum inventory. CMA Adapted – August 2015 E-8. Madina water tank company wants to produce new water pump besides is plastic water tank having estimated production capacity of 6250 units per month. Madina require to purchase similar quantity of valves in order to manufacture the water pump costing Tk.150.00 per. The carrying cost is estimated at 20% average inventory investment on the annual basis. The cost to place and process the delivery is Tk.1800.00 It takes 45 days to receive delivery from the date of an order and a safety stock is Tk.3,250 value is desired. Required: (i) The most economic order quantity and frequency of order in a year; (ii) The order point and; (iii) The most economic order quantity, if the valves cost Tk.450.00 each instead of Tk.150.00 each. CMA Adapted – August 2014 E-9. Moyun Enterprise sells packages of blank tapes to its customers. It also rents out tape of movies and supporting events. It purchases packages of video tapes from Sony Trading at Tk.14 a package. Sony pays all incoming freight to Moyuri Enterprise. No incoming inspection is necessary because Sony has a superb reputation for delivering quality merchandise. Annual demand is 13,000 packages at a rate of 250 packages per week. Moyuri Enterprise requires a 15% annual return on investment. The purchase order lead time is two weeks. Ordering cost per order is Tk.200. Insurance, handling, breakage and so on per year is Tk.3.10. Required: Calculate: a) Economic Order Quantity. b) Annual relevant total cost. c) Number of deliveries in a year. d) Time to place new order if the lead time is 2 weeks and 250 packages is sold per week. e) Considering the above information and also assume that 1 of 7 different levels of demand will occur over the 2 weeks purchase order lead time and cost of stock out is Tk.4 per package, calculate optimum safety stock. 268


Total Demand 200 300 400 500 600 700 800 for two weeks units units units units units units units Probability 0.60 0.09 0.20 0.30 0.20 0.09 0.06 f) If that relevant ordering cost per purchase order is Tk.100 instead of Tk.200, calculate the cost of this prediction error (Compare with the EOQ as computed in requirement a). CMA Adapted – April 2014 E-10. A company requires 48,000 components per year which will be used as constant rate. Carrying costs are Tk.6.00 per unit. Per annum the cost per reorder is Tk.1000 irrespective of order size. Purchased orders are placed on the assumption that delivery will be received when stock components falls to zero. Required: (i) Calculate the cost per annum pursuing purchase order policies where the order size may be from 2000 to 6000 components in multiplies of 1000 components and hence state the purchase order quantity which will minimize cost. (ii) Use the economic order quantity formula to calculate the purchase order quantity that will minimize cost. (iii) Use the economic order quantity formula to calculate the EOQ where annual demand has risen to 96,000 components. CMA Adapted – December 2013 E-11. The following information has been gathered with regard to material X: Normal monthly usage 1400 units Maximum anticipated monthly usage 2000 units Minimum anticipated monthly usage 600 units Delivery period from suppliers: Maximum 4 months; Normal 3 months;

Minimum 2 months

Economic order quantity 6000 units. Required: (i) Reorder point or level (ii) Maximum Stock level (iii) Minimum Stock level CMA Adapted – December 2013 E-12. Monyem Limited uses a small casting in one of its finished products. The castings are purchased from a foundry. Monyem Limited purchases 54,000 castings per year at a cost of Tk.800 per casting. The castings are used evenly throughout the year in the production process on a 360-day-peryear basis. The company estimates that it costs Tk.9,000 to place a single purchase order and about Tk.300 to carry one casting in inventory for a year. The high carrying costs result from the need to keep the castings in carefully controlled temperature and humid conditions and the high cost of insurance. Delivery from the foundry generally takes 6 269


days, but it can take as much as 10 days. The days of delivery time and percentage of their occurrence are shown in the following table: Delivery time (days) : 6 7 8 9 10 Occurrence : 75% 10% 5% 5% 5% Required: (i) Compute the economic order quantity (EOQ). (ii) Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock? The re-order point? (iii) Assume 5% stock-out risk. What would be the total cost of ordering and carrying inventory for one year? (iv) Refer to the original data. Assume that using process re-engineering the company reduces its cost of placing a purchase order to only Tk.600. In addition, company estimates that when the waste and inefficiency caused by inventories are considered, the true cost of carrying a unit in stock is Tk.720 per year. (a) Compute the new EOQ. (b) How frequently would the company be placing an order, as compared to the old purchasing policy? CMA Adapted – August 2013 E-13. BIM Computers sells its popular PC-PAL model to distributors at a price of $1,250 per unit. BIM‟s profit margin is 20%. Factory orders average 400 units a week. Currently, BIM works in a batch mode and produces a 4-week supply in each batch. BIM‟s production process involves three stages: • PC board assembly (the automatic insertion of parts and the manual loading, wave soldering, and laser bonding of electronic components purchased from outside sources), • Final assembly, and • Testing. When the firm wants to change production from one model to another, it must shut down its assembly line for half a way. The company estimates that downtime costs one-half hour of supervisory time and an additional $2,000 in lost production and wages paid to workers directly involved in changeover operations. Salaries for supervisory personnel involved amount to $1,500 a day. Although BIM products are generally regarded as high quality, intense price competition in the industry has forced the firm to embark on a cost-cutting and productivityimprovement campaign. In particular, BIM wants to operate with lower inventories but without sacrificing customer service. Releasing some of the funds tired up in outputs inventory would allow BIM to invest in a new product development project that is expected to yield a risk-adjusted return of 20%. Assume 50 workweeks in a year; 5 working days in a week and 8 working hours per day. Required: (i) Determine BIM‟s total annual cost of production and inventory control. (ii) Compute the economic batch size and the resulting cost savings. CMA Adapted – April 2013

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E-14. Garish Woodcrafts use mathematical modeling to control inventory. For a typical year, you have been provided with the following information: Monthly Requirements 3,000 units Selling Price/Unit Tk. 900 Lead Time 6 days Normal Usage 100 units/day Maximum Usage 150 units/day Minimum usage 50 units/day Cost/Unit Tk.500 Transportation cost each time Tk.150 Documentation cost to place the order Tk.120 Inspection cost for checking each time Tk.180 Storing cost of each inventory Tk. 20 Finance cost of each inventory Tk. 40 Insurance cost per inventory Tk. 15 Loading and Unloading cost Tk.300 Required: (i) Compute economic order quantity. (ii) Compute the total amount of carrying and ordering costs for the year. (iii) Compute the amount of safety stock, if any. (iv) Compute the amount of normal maximum inventory. (v) Compute the amount of absolute maximum inventory. (vi) Determine the number of days until the next order should be placed, assuming that the present inventory level is 1,200 units. (360 days = 1 year) (vii) Why do you need to maintain safety stock in this situation? CMA Adapted – December 2012 E-15. ABC company has obtained the following costs and other data pertaining to one of its materials: Working days per year 250 Normal use per day 500 units Maximum use per day 600 units Minimum use per day 100 units Lead time 5 days Variable cost of placing one order Tk.36 Variable carrying cost per unit per year Tk.4 Required: compute the followings: 1. Economic order quantity. 2. Safety stock (maximum) 3. Order point 4. Normal maximum inventor 5. Absolute maximum inventory CMA Adapted – August 2012 E-16. Amberin Incorporation prepares DVDs with antivirus program to be sold in computer retail shops. The company President has been wondering how much blank DVDs to buy at a time, and when an order should be placed. Ha wants a safety stock of 271


140 DVDs and has estimated that his company uses 9000 DVDs annually. Ordering cost is Tk.6.40 per order and carrying cost per DVD in inventory is Tk.2.00. The company operates 300 days a year. It takes 7 days from placement of an order to arrival of the DVDs. Required: (i) Determine the Economic Order Quantity. (ii) Compute the Order Point. (iii) Disregards the amount of Safety Stock and assume the following estimates: Cost of a stock out Tk.32 per occurrence number of orders per year 38. There will be no change in carrying cost. Estimated stock out probabilities: Units of safety stock Probability of stock out (%) 50 70 100 45 200 25 300 10 400 05 Find out the optimal safety stock for Amberin Incorporation. CMA Adapted – December 2011 E-17. Supermax Company sells a number of products through its many sells centre. One of the products is plastic razor with five blades in a package. The sale price of blade with razor is Tk.55.00. The package of 5 blades sells Tk.35.00 per package. The demand for the replacement blades is at a constant rate 20,000 packages per month. The cost of manufacturer per package is Tk.20.00. The minimum lead time 7 days from date of order. The ordering cost is Tk.1200.00 & holding cost is 10% per annum. The Supermax company uses the EOQ formula. Required: (i) The economic order quantity. (ii) The number of orders needed per year. (iii) The total cost of buying and carrying blades for the year. (iv) Assuming there is no safety stock and the present inventory level is 4,667, when should be the next order be placed (One year = 360 days) (v) Describe the shortcomings of EOQ formula. CMA Adapted – August 2011 E-18. Ajek company has obtained the following costs and other data pertaining to one of its materials: Working days per year 250 Normal use per day 500 units Maximum use per day 600 units Minimum use per day 100 units Lead time 5 days Variable cost of placing one order Tk.36 Variable carrying cost per unit per year Tk.4

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You are required to compute: (i) EOQ. (ii) Safety stock (Maximum). (iii) Order point (iv) Normal maximum inventory. (v) Absolute maximum inventory (vi) Average inventory, assuming normal lead time and usage. CMA Adapted – December 2010 E-19. M Ltd. produces a product which has a monthly demand of 4,000 units. The product requires a component X which is purchased at Tk.20. For every finished product, one unit of component is required. The ordering cost is Tk.120 per order and the holding cost is 10% p.a. You are required to calculate; (i) EOQ (ii) If the minimum lot size to be supplied is 4,000 units, what extra cost the company has to incur? (iii) What is the minimum carrying cost the company has to incur? CMA Adapted – August 2010 E-20. Jubayer Company sells a number of products to many restaurants in the area. One product is a special meat cutter with a disposable blade. Blades are sold in a package of 12 blades at Tk. 20 per package. It has been determined that the demand for the blades is at a constant rate of 2,000 packages per month. The packages cost to the company is Tk. 10 each from the manufacturer and require a three-day lead time from date of order to date of delivery. The ordering cost is Tk. 1.20 per order, and the carrying cost is 10% per annum. The company uses the economic order quantity formula. Required: (i) Compute the economic order quantity. (ii) Compute the number of orders needed per year. (iii) Compute the cost of ordering and of carrying blades for the year. CMA Adapted – April 2010 E-21. The Best Supply Company has been experiencing stock outs on one of it important materials, even though deliveries are dependable within one month from the date of an order. Management asks that a safety stock for this item be established and provides the following records of actual and forecast usages during the past 9 (nine) months: Month Usage Forecast January 475 490 February 480 490 March 490 475 April 500 485 May 510 500 June 520 510 July 500 510 August 490 510 September 485 500 273


It is believed that 90 to 95 percent protection against a stock out is adequate. This protection can be achieved by doubling the deviation found. Requirement: (a) A schedule showing the safety stock required. (b) The safety stock required if the lead time is 2 (two) months. CMA Adapted – December 2009 E-22. Strickland Company sells a number of products to many restaurants in the area. One product is a special meat cutter with a disposable blade. Blades are sold in a package of 12 blades at Taka 20 per package. It has been determined that the demand for the replacement blades is at a constant rate of 2,000 packages per month. The packages cost the company Taka 10 each from the manufacturer and require a three-day lead time from date of order to date of delivery. The ordering cost is Taka 1.20 per order, and the carrying cost is 10% per annum. The company uses the economic order quantity formula. Required: (i) Compute the economic order quantity. (ii) Compute the number of orders needed per year. (iii) Compute the cost of ordering and of carrying blades for the year. (iv) Determine the date on which the next order should be placed, assuming that there is no reserve (safety stock) and the present inventory level is 200 packages (360 days = 1 year). (v) Discuss the difficulties that most firms would have in attempting to apply the EOQ formula to their inventory problems. CMA Adapted – April 2009

274


MODEL EXAM QUESTION SUBJECT: PERFORMANCE OPERATIONS Time: Three hours ______ Full marks: 100 * All questions are to be attempted. * Show computations, where necessary. * Answer must be brief, relevant, neat and clean. * Start answering each question from a fresh sheet __________ . Q. No. 1. Why is process re-engineering a more radical approach to improvement than Total Quality Management (TQM)? [Marks: 5] Q. No. 2. Under absorption costing, how is it possible to increase net operating income without increasing sales? [Marks: 5] Q. No. 3. What are the major benefits of JIT system? In a JIT system, what is meant by the pull approach to the flow of goods, as compared to the push approach used in conventional system? [Marks: 5] Q. No. 4 “Education and salesmanship are key features of budgeting�- Explain. [Marks: 5] Q. No. 5. Nobbodoy Company uses a back-flush accounting system with three trigger points: * Purchase of direct materials * Completion of goods finished units of product * Sale of finished goods There are no beginning inventories. Information for April 2017 is: Direct material purchased Tk.88,00,000 Direct material used Tk.85,00,000 Conversion cost allocated Tk.40,00,000 Conversion cost incurred Tk.42,00,000 Cost transferred to finished goods Tk.1,25,00,000 Cost of goods sold Tk.1,19,00,000 Required: (a) Prepare journal entries for April (without disposing of underallocated or overallocated conversion costs). Assume there are no direct materials variances. (b) Under an ideal JIT production system, how would the amounts in your journal entries differ from the journal entries in requirement (a)? [Marks: 5 + 5 = 10] Q. No. 6. Crossman Corporation, a rapidly expanding crossbow distributor to retail outlets, is in the process of formulating plans for next year. Ms. Ismat Jahan, Director of Marketing, has completed her sales budget and is confident that sales estimates will be met or exceeded. Page 1 of 4 275


The following budgeted sales figures show the growth expected and will provide the basis for planning within other corporate departments. Budgeted sales are: January February March April May June

Tk.18,00,000 Tk.20,00,000 Tk.18,00,000 Tk.22,00,000 Tk.25,00,000 Tk.28,00,000

July August September October November December

Tk.30,00,000 Tk.30,00,000 Tk.32,00,000 Tk.32,00,000 Tk.30,00,000 Tk.34,00,000

Mr. Shaad Hossain, Management Accountant, has been given the responsibility for formulating the cash budget, a critical task during a period of rapid expansion. The following information provided by operating managers will be used in preparing the cash budget. (a) Crossman collects 60% of credit sales in the month after the sale and 40% in the second month after the sale. Uncollectible accounts are negligible. (b) The purchase cost of crossbows equals 50% of sales. Sixty percent of the crossbows are received one month prior to sale and 40% are received during the month of sale. (c) Prior experience shows that 80% of accounts payable are paid by Crossman one month after receipt of the purchased crossbows and the remaining 20% are paid the second month after receipt. (d) Hourly wages, including fringe benefits, depend on sales volume and are equal to 20% of the current month‟s sales. These wages are paid in the month incurred. (e) General and administrative expenses are budgeted to be Tk.25,40,000 for the year. The composition of these expenses is given below. All of these expenses are incurred evenly throughout the year except the property taxes. property taxes are paid in four equal installments in the last month of each quarter. Salaries Tk.4,80,000 Promotion Tk.6,60,000 Property taxes Tk.2,40,000 Insurance Tk.3,60,000 Utilities Tk.3,00,000 Depreciation Tk.6,00,000 Total Tk.26,40,000 (f) Income tax payments are made by Crossman in the first month of each quarter based on the income for the prior quarter. Crossman‟s income tax rate is 40%. Crossman‟s net operating income for the first quarter is projected to be Tk.6,12,000. (g) Equipment and warehouse facilities are being acquired to support the company‟s rapidly growing sales. Purchases of equipment and facilities are budgeted at Tk.28,000 for April and Tk.3,24,000 for May. (h) Crossman has a corporate policy of maintaining an end-of-month cash balance of Tk.1,00,000. Cash is borrowed or invested monthly, as needed, to maintain this balance. Interest expense on borrowed funds is budgeted at Tk.8,000 for the second quarter, all of which will be paid during June. Required: Prepare a cash budget for Crossman Corporation by month and in total for the quarter ended June 30. Be sure that all receipts, disbursements and borrowing/ investing amounts are shown for each month. Ignore any interest income associated with amounts invested. [Marks: 20] Page 2 of 4 276


Q. No. 7. The Atlas Corporation has a machining facility specializing in jobs for the aircraft components market. Atlasâ€&#x;s previous simple job-costing system had two direct-cost categories (direct materials and direct manufacturing labor) and a single indirect-cost pool (manufacturing overhead, allocated using direct manufacturing labor-hours). The indirect cost-allocation rate of the simple system for 2017 would have been Tk.115 per direct manufacturing labor-hour. Recently a team with members from product design, manufacturing, and accounting used an ABC approach to refine its job-costing system. The two direct-cost categories were retained. The team decided to replace the single indirect-cost pool with five indirect-cost pools. The cost pools represent five activity areas at the plant, each with its own supervisor and budget responsibility. Pertinent data are as follows: Activity Area Cost Collection Base Cost Allocation Rate Material Handling Parts Tk.0.40 Lathe Work Lathe Unit 0.20 Milling Machine-hour 20.00 Grinding Parts 0.80 Testing Units Tested 15.00 Information-gathering technology has advanced to the point at which the data necessary for budgeting in these five activity areas are collected automatically. Two representative jobs processed under the ABC system at the plant in the most recent period had the following characteristics: Particulars Job 410 Job 411 Direct material cost per job Tk.9,700 Tk.59,900 Direct manufacturing labor cost per job Tk.750 Tk.11,250 Number of direct manufacturing labor-hours per job 25 375 Parts per job 500 2,000 Lathe turns per job 20,000 59,250 Machine-hours per job 150 1,050 Units per job (all units are tested) 10 200 Required: (a) Compute the manufacturing cost per unit for each job under the previous simple job costing system. (b) Compute the manufacturing cost per unit for each job under the previous activity-based costing system. (c) Compute the per-unit cost figures for Jobs 410 and 411 computed in requirements (a) and (b). (d) Why do the simple and activity-based costing systems differ in the manufacturing cost per unit for each job? (e) Why might these differences be important to Atlas Corporation? [Marks: 25] Q. No. 8. (a) XYZ Company uses a material 30,000 units per year for which cost of placing one order is Tk.40, unit carrying cost is Tk.96 and carrying cost percentage is 10%. The company follows JIT inventory system and the order size may be from 500 to 800 units in multiplies of 100. You are required to determine the purchase order quantity that will minimize cost by tabular method. Apply the EOQ formula to prove your answer. Page 3 of 4 277


(b) Sandia Company currently produces two products, A and B. The company has sufficient floor space to manufacture an additional product with two (C and D) currently under consideration. Only one of the two products can be chosen. The expected annual sales and associated costs for each product are as follows: Product C Product D Tk. Tk. Sales 100,000 125,000 Variable cost as a percentage of sales production 54% 65% Selling and administration expenses 12% 5% Direct fixed expenses 15,000 11,250 The common fixed costs are allocated to each product line on the basis of sales revenues. The following income statement for the last yearâ€&#x;s operation is also available: Product A Product B Total Tk. Tk. Tk. Sales 250,000 375,000 6250,000 Less: Variable expenses Production (100,000) (250,000) (350,000) Selling and administration (20,000) (65,000) (85,000) Contribution margin 130,000 60,000 190,000 Less: Direct fixed expenses (10,000) (55,000) (65,000) Segment margin 120,000 5,000 125,000 Less: Common fixed cost (75,000) Net income 50,000 Required: Prepare an income statement that reflects the impact on the firmâ€&#x;s profits on adding product C. Repeat for product D. Which of the two would you recommend adding? [Marks: 10 + 15 = 25]

Page 4 of 4 278


MODEL EXAM QUESTION SOLUTION

279


Ans. to the Q. No. 1

Process reengineering is more radical approach in improvement than TQM because in process reengineering a business process is diagrammed in detail, questioned and then completely redesigned instead of changing the existing system. Process reengineering eliminates unnecessary steps and reduces the possibility errors. Process reengineering is similar in some respects to TQM. One of the major differences is that TQM emphasizes with people who work directly in the process but process reengineering emphasizes with people who work directly in the process and with the outside consultants. Process reengineering is simpler and less costly than TQM.

280


Ans. to the Q. No. 2

Under absorption costing it is possible to increase net operating income by increasing the level of production without any increase in sales. If production exceeds sale, units of product are added to inventory. These units carry a portion of the current periodâ€&#x;s fixed manufacturing overhead costs into the inventory account, thereby reducing the current periodâ€&#x;s reported expenses and causing net operating income to increase.

281


Ans. to the Q. No. 3

The major benefits of JIT system are as follows: 1. It reduces defective rates and wastage in inventory 2. It reduces time 3. It increases effective output 4. It allows quicker response to customers 5. It increases customer satisfaction In a just-in-time (JIT) system, the flow of goods is controlled by a pull approach. The pull approach states that at the final assembly stage, a signal is sent to the preceding workstation so that exact amount of materials that will be needed over the next few hours to assemble products and to fill customer orders can be determined and only that amount of material is provided. The same signal is sent back through each preceding workstation so that a smooth flow of material is maintained. In a conventional system, the flow of goods is controlled by a push approach. This approach states that when a workstation partially completes its work the partially completed goods are pushed forward to the next workstation whether the workstation is not ready to receive them. The result is a stockpiling of partially completed goods.

282


Ans. to the Q. No. 4

Budgeting is a time consuming process that involves all levels of management. Top managers want lower-level managers to participate in the budgeting process because lower-level managers have more specialized knowledge and first-hand experience with day-to-day business. Participation creates greater commitment and accountability among lower-level managers. So, there are a mix-up of knowledge and experience which is provided by the education and salesmanship of the persons involved in budgeting. So, education and salesmanship are key features of budgeting.

283


Ans. to the Q. No. 5 (a)

Si. No. i.

ii

iii.

iv.

Nobbodoy Company Journal entries For the month of April Particulars Inventory materials and in-process Accounts payable (direct materials purchased) Conversion costs Various accounts (conversion cost incurred) Finished goods Inventory materials and in-process Conversion cost allocated (standard cost of finished goods completed) Cost of goods sold Finished goods (standard cost of finished goods sold)

Dr. (Tk.) 88,00,000

Cr. (Tk.) 88,00,000

42,00,000 42,00,000 1,25,00,000 85,00,000 40,00,000 1,19,00,000 1,19,00,000

(b) Under an ideal JIT production system, if the manufacturing lead time per unit is very short, there could be zero inventories at the end of each day. Entry (iii) would be Tk.1,19,00,000 finished goods production [to match finished goods sold in entry (iv)], not Tk.1,25,00,000. If the marketing department could only sell goods costing Tk.1,19,00,000, the JIT production system would call for direct materials purchases and conversion costs of lower than Tk.88,00,000 and Tk.42,20,000, respectively in entries (i) and (ii).

284


Ans. to the Q. No. 6

Crossman Corporation Cash budget

Cash balance, beginning Add. Cash receipts (w1) Total cash available Less. Cash disbursements Payment for purchases (w2) Wages (20% of sales) General and admin. (w3) Income taxes (w4) Equipment and facilities Total cash disbursements Excess (deficiency) of cash available over disbursements Financing Borrowings Repayments Interest Invested funds Total financing Cash balance, ending

285

April Tk. 100,000 18,80,000 19,80,000

May Tk. 100,000 20,40,000 21,40,000

June Tk. 100,000 23,80,000 24,80,000

Quarter Tk. 100,000 63,00,000 64,00,000

10,04,000 4,40,000 1,50,000 4,08,000 28,000 20,30,000

11,56,000 13,10,000 5,00,000 5,60,000 1,50,000 2,10,000 3,24,000 _______21,30,000 20,80,000

34,70,000 15,00,000 5,10,000 4,08,000 3,52,000 62,40,000

(50,000)

10,000

4,00,000

1,60,000

1,50,000 ______1,50,000 1,00,000

90,000 _____90,000 1,00,000

(240,000) (8,000) (52,000) (300,000) 1,00,000

2,40,000 (240,000) (8,000) (52,000) (60,000) 1,00,000


Workings: 1. Cash receipts from sales:

February sales (20,00,000X40%) March sales (18,00,000 X 60%, 40%) April sales (22,00,000 X 60%, 40%) May sales (25,00,000 X 60%) Total cash receipts

April Tk. 800,000 10,80,000 18,80,000

May Tk. 7,20,000 13,20,00 20,40,000

June Tk. 8,80,000 15,00,000 23,80,000

Quarter Tk. 800,000 18,00,000 22,00,000 15,00,000 63,00,000

2. Payment to suppliers: Determination of cost of purchases: February March April May June July Tk. Tk. Tk. Tk. Tk. Tk. 50% of sales 10,00,000 9,00,000 11,00,000 2,50,000 14,00,000 15,00,000 Budgeted purchases: February March April May June Tk. Tk. Tk. Tk. Tk. For this month sales @ 40% 400,000 360,000 440,000 500,000 560,000 For next month sales @ 60% 540,000 660,000 750,000 840,000 900,000 Total 940000 1020000 1190000 1340000 1460000 Payment for purchases: April May June Quarter Tk. Tk. Tk. Tk. February purchases (,940,000X20%) 188,000 March purchases (10,20,000X80%,20%) 816,000 204,000 April purchases (11,90,000X80%,20%) - 952,000 238,000 May purchases (13,40,000X80%,20%) - 1,072,000 Total 1004,000 1156,000 1310,000 3470,000 3. General and administrative expenses:

Salaries (1/12 of annual) Promotion (1/12 of annual) Property taxes (1/4 of annual) Insurance (1/12 of annual) Utilities (1/12 of annual) Depreciation (Non-cash item) Total

April Tk. 40,000 55,000 30,000 25,000 150,000

May Tk. 40,000 55,000 30,000 25,000 150,000

June Quarter Tk. Tk. 40,000 55,000 60,000 30,000 25,000 210,000 510,000

4. Income tax:

Tk.6,12,000 1  0.4 = Tk.10,20,000 Income tax = Tk.10,20,000 X 40% = Tk.4,08,000 Income before tax =

286


Ans. to the Q. No. 7

(a) Computation of manufacturing cost under simple job costing system:

Direct material Direct manufacturing labor Tk.30 X 25, Tk.30 X 375 Indirect material cost Tk.115 X 25, Tk.115 X 375 Total manufacturing cost Divided by number of units Manufacturing cost per unit

Job 410 Tk. 9,700 750

Job 411 Tk. 59,900 11,250

2,875

43,125

13,325 10 1,332.500

114,275 200 571.375

(b) Computation of manufacturing cost under activity-based costing system:

Direct material Direct manufacturing labor Tk.30 X 25, Tk.30 X 375 Indirect material cost: Material handling Tk.0.40 X 500, Tk.0.40 X 2,000 Lathe work Tk.0.20 X 20,000, Tk.0.20 X 59,250 Milling Tk.20 X 150, Tk.20 X 1,050 Grinding Tk.0.80 X 500, Tk.0.80 X 2,000 Testing Tk.15 X 10, Tk.15 X 200 Total manufacturing cost Divided by number of units Manufacturing cost per unit

Job 410 Tk. 9,700 750

Job 411 Tk.

200

800

4,000

11,850

3,000

21,000

400

1,600

150

3,000

18,200 10 1,820.00

109,400 200 547.00

Job 410 Tk. 1,332.500 1,820.00

Job 411 Tk. 571.375 547.00

11,250

(c) Per-unit cost figures:

Cost per unit under simple job costing system Cost per unit under activity-based costing system

287


(d) Product cost figures computed in requirements (a) and (b) differ because - the job order differ in the way they use each of five activity areas, and - the activity areas differ in their indirect cost allocation bases (specifically, each area does not use the direct manufacturing labor hours indirect cost allocation base).

(e) The difference in product cost figures might be important to Atlas Corporation for product pricing and product emphasis decisions. The activity-based accounting system indicates that Job 410 is being under-costed while Job 411 is being over-costed. Atlas Corporation may erroneously push Job 4100 and deemphasize Job 411. Moreover, by its actions, Atlas Corporation may encourage a competitor to enter the market for Job 411 and take market share away from it.

288


Ans. to the Q. No. 8 (a)

Determination of cost per annum that will minimize cost by tabular method: Order size in units (Q) No. of order per year (D/Q) Average inventory in units (Q/2) Total ordering cost in Tk. (D/Q X Tk.40) Total carrying cost in Tk. (Q/2 X Tk.96 X 10%) Total cost in Tk. (Ordering + Carrying cost)

500 60 250 2,400

600 50 300 2,000

700 42.86 350 1,714

800 37.50 400 1,500

2,400

2,880

3,360

3,840

4,800

4,880

5,074

5,340

As, the total cost Tk.4,800 is minimum when the purchase order quantity is 500 units. So, it will minimize cost.

Applying the EOQ formula: Economic order quantity (EOQ) = =

2 DO C C%

2 X 30,000 X 40 96 X 10%

24,00,000 9.6 = 500 units =

289


(b)

Sales Variable expenses: Production Selling and administration Contribution margin Direct fixed expenses Segment margin Common fixed cost Net income

Sales Variable expenses: Production Selling and administration Contribution margin Direct fixed expenses Segment margin Common fixed cost Net income

Sandia Company Income Statement Product A Product B Tk. Tk. 250,000 375,000 (100,000) (20,000) 130,000 (10,000) 120,000

(250,000) (65,000) 60,000 (55,000) 5,000

Sandia Company Income Statement Product A Product B Tk. Tk. 250,000 375,000 (100,000) (20,000) 130,000 (10,000) 120,000

(250,000) (65,000) 60,000 (55,000) 5,000

Product C Tk. 100,000

Total Tk. 725,000

(54,000) (404,000) (12,000) (97,000) 34,000 224,000 (15,000) (80,000) 19,000 144,000 75,000 69,000

Product D Tk. 125,000

Total Tk. 750,000

(81,250) (431,250) (6,250) (91,250) 37,500 227,500 (11,250) (76,250) 26,250 151,250 75,000 76,250

Product D is preferable on financial consideration.

290


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